Israel central bank highlights risk of house price slump

JERUSALEM, Jan 21 (Reuters) - Israel's central bank said on Wednesday the main risk to the stability of the country's financial system was the exposure of banks and households to a potential slump in house prices, which have nearly doubled since 2007.

The assessment was contained in the second report from the bank's financial stability division, established in 2013, which said that while the system was stable at present house prices could drop, with damaging consequences, if an unexpected shock forced the country to raise interest rates.

"The financial system is exposed to the risk of a sharp decline in home prices, which could result from a domestic or external shock that leads to a sharp and rapid increase in interest rates or from a recession that negatively impacts on borrowers' income," the report said.

"Either scenario, or some combination of both, is liable to make it more difficult for households and contractors to meet their obligations and thus would negatively impact on banks' capital ratios."

While there was a slowdown in the housing market in the second and third quarters of 2014 due to expectations the government would change value added tax rules, demand for home loans had increased again by the end of the year when new elections were called and the plan was shelved, the report said.

The central bank said the financial system was also exposed to the underpricing of risks in the corporate bond market against the background of low interest rates in Israel and abroad.

Israel's 50-day war with Palestinian militants in Gaza in July and August, contributed to a slowdown in economic growth to an estimated 2.6 percent in 2014 from 3.2 percent in 2013, the bank said, but added that the financial system had been able to maintain its stability in the second half of 2014.