Israeli financial-market response to the 2008 global financial crisis

The Israeli financial-market response to the 2008 global financial crisis describes the effects of the international shock on Israel’s equity, corporate-bond, banking, savings and credit markets, together with the policy actions taken to contain disruption. Israel’s markets began reacting in 2007, but the domestic stress intensified in late 2008. Banks remained operational and comparatively resilient, while falling asset prices and the interruption of non-bank credit became central features of the episode. ^[1][2]

Background and timing

The crisis originated in the United States housing and financial sectors and spread internationally. In Israel, financial markets reacted from July 2007, although the domestic economy was initially regarded as relatively insulated. The failure of Lehman Brothers in September 2008 and the ensuing escalation in global credit-market stress changed that assessment. The Bank of Israel later identified the fourth quarter of 2008 and the first quarter of 2009 as the peak period for the crisis in Israel, both in market conditions and in uncertainty about the outlook. ^[1]

The timing mattered because Israel entered the global downturn after several years of strong economic growth. Growth continued during the first half of 2008, but activity weakened in the second half as external demand and trade deteriorated. The Bank of Israel’s 2008 report described a turning point in the second half of the year, with the economy moving toward recession; the fourth-quarter contraction followed the slowdown. ^[1][3]

The impact was not uniform across the financial system. The stress on markets was substantial, but Israeli banks and other financial institutions were not hit in the same way as many institutions abroad. The Bank of Israel attributed relative resilience to factors including conservative banking practices, close supervision, stronger pre-crisis conditions and limited exposure to complex or impaired foreign assets. This distinction—market disruption without a domestic banking collapse—shaped the episode. ^[2][4]

Equities and corporate bonds

Share prices and corporate-bond prices fell sharply as investors reassessed the outlook for economic activity and the ability of businesses to repay debt. Volatility increased, and credit-market yield spreads widened, raising the cost of financing. The Bank of Israel’s assessment of the 2008 financial system described the domestic market reaction as a reflection of concern about the crisis’s implications for Israeli real activity, including corporate earnings and repayment capacity. ^[3]

The shock was especially important for the Israeli corporate bond market. In the years before the crisis, companies had increasingly raised funds outside the banking system, including through bond issues. The market’s fast expansion had helped broaden business financing, but the Bank of Israel later identified vulnerabilities associated with its rapid and unbalanced development. Some proceeds had supported investment in overseas real estate, a sector directly exposed to the global downturn. ^[4]

As uncertainty rose, investors sought lower-risk savings channels. Withdrawals from bond-focused mutual funds and provident funds forced some managers to sell assets, adding to selling pressure and contributing to higher corporate-bond yields. This feedback between redemptions, asset sales and falling prices intensified stress in an already illiquid market. ^[4]

Issuance in the capital market nearly stopped during the crisis, drying up an important source of non-bank credit. The Bank of Israel described the non-bank credit market as essentially paralyzed and as the principal area of risk in Israel’s financial system during the episode. Businesses that could not readily issue bonds faced tighter access to finance, increasing the importance of bank lending even as banks were also reassessing borrower risks. ^[1][2]

The market shock also affected household and institutional savings. Falling asset values and investor withdrawals placed pressure on funds holding corporate securities, while heightened uncertainty encouraged a shift toward lower-risk investments. These portfolio adjustments formed part of the transmission from international financial stress to domestic credit conditions. ^[4]

Banking-sector resilience

Compared with banking systems in many other countries, Israel’s banks weathered the crisis relatively well. They did experience losses and weaker business results: exposure to foreign financial institutions, declining asset values and deterioration in some borrowers’ repayment capacity reduced profitability. The five major banking groups reported much lower profits than in preceding years. However, the system remained stable, and no Israeli financial institution collapsed during the crisis, according to the Bank of Israel’s retrospective account. ^[1][2]

The Bank of Israel’s banking supervisor had encouraged banks, before the crisis, to raise capital adequacy gradually, with a target of at least 12 percent by the end of 2009. The banking system’s capital adequacy ratio reached 11.2 percent in 2008, its highest level since 1992 at that point, despite the difficult conditions. The central bank linked resilience to prudent capital policy, conservative activity, public confidence and close supervision. ^[2]

Banks also reduced certain risks during the international market disruption. The Bank of Israel’s annual reporting described supervisory requirements that included selling mortgage-backed securities and reducing exposure to foreign financial institutions, particularly during the final quarter of 2008. These measures reflected the reassessment of counterparty and securities risks as the global crisis intensified. ^[5]

The contrast between stable banks and a disrupted corporate-bond market is a defining feature of Israel’s experience. While the banking system continued operating, the loss of market-based funding exposed firms and borrowers to a sharp contraction in non-bank credit. The disruption therefore concerned the supply and cost of financing as well as the solvency of financial institutions. ^[1][2]

Policy response

The Bank of Israel and the government adopted measures intended to support credit availability, reduce financing costs and sustain economic activity. The response included substantial reductions in the policy interest rate, intervention in foreign-exchange markets, purchases of government bonds, and government guarantees for local banks raising capital. A separate programme, known as the Manof (Leverage) funds, was established to support credit-market activity. ^[4]

Monetary policy shifted as the economic outlook and inflation conditions changed. During 2008, the Bank of Israel moved from addressing high inflation pressures earlier in the year toward easing policy as the crisis deepened and activity weakened. The rate was cut further during 2009, reaching 0.5 percent in April. The Bank of Israel also bought government bonds in the secondary market, seeking to lower longer-term interest rates and support liquidity and the transmission of monetary policy. ^[3][6]

Foreign-exchange intervention was another part of the response. The Bank had begun buying foreign currency in March 2008 to increase reserves amid appreciation of the shekel. Purchases increased considerably in the second half of 2008 and during 2009. The stated aims included limiting sharp appreciation, which could weigh on exporters, and reducing deflationary pressure. ^[6]

The government’s guarantees for local banks were intended to facilitate capital raising, while the Manof funds addressed the breakdown in non-bank financing. These actions reflected the authorities’ concern that a prolonged interruption in capital-market lending could further constrain business activity. The measures formed part of a broader policy effort to maintain the flow of credit as private issuance contracted. ^[4]

Economic effects and recovery

The financial shock coincided with a slowdown in the wider economy. The Bank of Israel reported that export demand was particularly affected as world trade contracted. The economy experienced a decline in activity at the end of 2008 and beginning of 2009, followed by a recovery beginning in the second quarter of 2009. Israel’s GDP grew by 0.7 percent in 2009, according to the Bank of Israel, with contraction in the first half and growth in the second. ^[6]

Financial-market recovery began toward the end of the first quarter of 2009, alongside the improvement in global markets. Corporate-bond issuance, which had practically halted at the crisis peak, resumed during 2009. Market spreads and volatility declined gradually, while non-resident portfolio investment increased. The Bank of Israel reported that these indicators moved closer to pre-crisis levels as the recovery gained momentum. ^[1][6]

The crisis had a more moderate effect on Israel than on many advanced economies, but it exposed vulnerabilities in financing outside the banking system. The rapid pre-crisis growth of corporate bond issuance had expanded available credit, yet it also left companies and investors exposed to liquidity and valuation shocks. The episode consequently brought attention to the links among institutional savings, bond-market liquidity, corporate borrowing and bank credit. ^[4]

Significance

Israel’s experience is often characterized by two simultaneous outcomes: resilience in the regulated banking sector and severe stress in market-based credit. The stability of banks helped prevent the crisis from becoming a domestic banking collapse, but it did not prevent steep declines in securities prices or the near-halt in new capital-market issuance. The financial consequences therefore appeared substantially through tighter credit, higher financing costs, lower asset values and weaker economic activity. ^[1][2][3]

The episode also informed subsequent discussion of financial oversight and systemic risk. The Bank of Israel’s later review described the crisis as revealing the importance of monitoring non-bank credit alongside banks, particularly where corporate borrowing and institutional investment are closely connected. Its retrospective account emphasized that the authorities maintained financial stability, while acknowledging that there had been real contemporaneous concerns about certain institutions and the proper functioning of markets. ^[1]

Related entries

The episode connects to the Israeli equity market, the Israeli corporate bond market, Israeli government bonds and the Bank of Israel interest rate. The Israeli financial literacy and savings landscape also provides context for how households and institutions responded to falling asset prices and market uncertainty.