S&P Warns Israel Banks Face Profit Pressure as Cheap Deposits Decline
S&P Global Ratings has issued a warning about structural changes in the funding sources of Israel's banking system, which could significantly erode bank profitability in the coming years. Between 2021 and 2025, the five largest Israeli banks saw their net credit to the public grow by 46.2%, while public deposits increased by only 30.3%, pushing the loan-to-deposit ratio to about 80%. Concurrently, Israeli savers are shifting funds from low-yield bank deposits to higher-yield investment alternatives such as money market funds.
This shift has led institutional investors and large corporations to fill the deposit gap, increasing their share of total deposits from around 20% in 2021 to 28% by the end of 2025. S&P views this as a structural change rather than a temporary trend. The main consequence is a rise in marginal funding costs for banks, as institutional deposits are 1% to 2.1% more expensive than household deposits. Additionally, institutional investors have stronger bargaining power and react more quickly to interest rate changes.
S&P's analysis shows that if institutional deposits reach 40% of total deposits, the banking sector's return on equity could decline sharply by 1.25% to 1.7%. The pressure on banks is intensified by three interest rate cuts by the Bank of Israel since early 2026, lowering rates to 3.5%. Lower rates reduce credit yields while funding costs remain high.
To cope, Israeli banks are diversifying funding sources, increasingly tapping domestic and international debt markets. In the first half of 2026, they raised over $5.3 billion through senior bonds, contingent convertible bonds, and mortgage-backed securities, a relatively new instrument led by Bank Leumi. While increased reliance on international markets exposes banks to foreign investor sentiment on Israel's geopolitical risks, S&P considers this risk limited due to the strong local savings market managing about 3.2 trillion shekels.
In its recent annual report on Israeli banking sector risk, S&P maintained a stable risk outlook but highlighted real estate exposure as a key vulnerability, with 21% of credit portfolios in this sector. It forecasts a 4.1% drop in real housing prices this year, following a 2.6% decline last year, amid a large unsold inventory and reduced transactions. Nonetheless, banks hold significant buffers, including a strong operational efficiency ratio of about 35%, a very low non-performing loan rate of 0.84%, and a coverage ratio of 150%, ensuring solid protection against credit risks.
