S&P Highlights Real Estate Risks but Praises Israeli Banks’ Operational Efficiency and Stability
The Israeli real estate and construction sector, which accounts for about 21% of the banking system's credit portfolios, is identified by S&P in its annual report as the main risk factor for the country's banks. The sector faces significant challenges including high financing costs, rising construction input prices, and a labor shortage due to only partial replacement of Palestinian workers with foreign labor. These pressures have squeezed contractors’ profitability and increased financial stress on the ground.
Economists cited by S&P forecast a real decline in housing prices of 2.6% in 2025, worsening to a 4.1% drop in 2026. Demand is falling, with monthly transactions dropping to an average of 7,500 units in 2026 compared to 8,600 in 2024, while an unprecedented inventory of approximately 85,000 unsold new homes has accumulated by March 2026. Developers are offering financing incentives and discounts that erode prices and strain cash flows.
Despite these sector pressures, S&P maintains Israel’s banking system risk rating at level four on a 1-to-10 scale, indicating moderate-low risk. This places Israel alongside countries like Poland and Iceland, just below the US, UK, and Spain. Two key factors support this stability: a remarkable improvement in operational efficiency, with the banks’ cost-to-income ratio dropping from about 65% in 2018 to roughly 35% in 2025-2027, and strong asset quality, with non-performing loans (NPLs) remaining low at 0.84% at the end of 2025 and expected to stay below 1% through 2028.
Credit losses are projected to rise only moderately from a low average of 0.15% in 2024-2025 to 0.2%-0.25% in 2026-2028. Banks have also maintained conservative loan loss provisions, covering 150% of problematic debt as of late 2025. However, S&P flags a concerning shift in banks’ funding structure. Israeli public deposits, which are cheaper funding sources, have declined sharply to 31.9% of total deposits by March 2026 from 42% at the end of 2020, as investors seek higher-yield alternatives. Consequently, banks rely more on expensive, concentrated corporate and institutional deposits, pushing interest-bearing and term deposits to 79% of total deposits by late 2025, up from 63% in 2021.
This funding cost increase is compressing banks’ net interest margins, which peaked at about 3.1% in 2023 but are forecast to fall to around 2.4% by 2027. To support credit growth, banks have increased international debt issuance, exposing them to refinancing risks if geopolitical tensions trigger foreign investors to withdraw. Domestically, institutional investors are expected to remain stable even during conflict.
On the macroeconomic front, S&P projects a sharp economic rebound of 5.9% growth in 2027 if no further security escalations occur. However, longer-term growth through 2028-2029 is expected to average only 3.5%, below pre-war trends, due to labor supply constraints, extended military service, and heavy reconstruction costs. These factors will keep net government debt high at 68% of GDP through 2029.
Government financing needs are directly affecting bank profitability. Following a special 6% tax on bank profits in 2024-2025, a new exceptional tax of 3 billion shekels for 2026 and 250 million shekels for 2027 has been imposed. This is expected to reduce the banking sector’s return on equity to 13.1% in 2026 from about 15.5% in 2025.
