1. The Israeli Economy: Current Trends & Policies Dr. Karnit Flug Governor of the Bank of Israel January 27 th, 2016 Jerusalem Press Club 1

2. Outline  Macro Economic Environment  Monetary Policy  The Competition in the Financial System 2

3. Macro Economic Environment

4. GDP Per Capita Growth Rates GDP per capita annual % change (2000-2015F) 4 SOURCE: TED, CBS (Israel) Israel Developin g Economie s Develope d Economi es *Simple average for 21 rich OECD countries and emerging markets according to IMF definition

5. Israeli Exports World Trade SOURCE: Bank of Israel and IMF 5 *Excl. diamonds and start-ups Israel’s Goods and Services Exports and World Trade, 1995-2016 Index 2008=100

6. % % Source: Central Bureau of Statistics Labor Force Survey Labor Market Quarterly, 1995-2015, 25-64 Participation Rate Employment rate Unemployment rate 6

7. 7 % SOURCE: Based on Central Bureau of Statistics Data Women Employment Rate, 25-64 % Men Employment Rate, 25- 64 Employment Rate by Population Groups

8. Real Wage per Employee Post* 1995-2015 NIS *Seasonally adjusted, 12 months moving average, 2015 prices Source: Central Bureau of Statistics Data 8

9. Monetary Policy

10. BOI’s Policy Objectives  Maintain price stability, as the central goal  Support economic policy, primarily growth, employment and reducing social gaps  Support the stability and orderly activity of the financial system 10

11. % Inflation 12 month Actual Inflation 2006-2015 11 SOURCE : Bank of Israel

12. Inflation excluding energy and regulation Inflation excluding energy, food, fruit and vegetables, and regulation Source: CBS (Israel) & BOI Headline inflation Factors of a One-Off Nature and Energy Prices Contribute to the Low Inflation 12 %Energy and Commodity Prices Declined *12-month % change 0.7 0.3

13. 13 Middle and Long Term Inflation Expectations Are Well Anchored in the Target Range 3-5 years 5-10 years Source: BOI % Forward Inflation Expectations, 2012-2016

14. Exchange Rates 2012-2016 NIS Inde x Nominal Effective 14 Source: BOI

15. Index Home Prices and Loans for Residential Purposes 2005-2015, Monthly SOURCE : Bank of Israel, Banking Supervision Department 15

16. Bank of Israel Policy Tools 2007-2016 FX Intervention (US$) Interest Rate (%) Additional provision for high LTV loans Higher capital requireme nts for high LTV Variable Interest Rate limit LTV limit PTI limit and capital requirem ent Higher capital requirements for high LTV Bond purchases 18 Billion NIS Higher capital requirements Macroprudentia l Measures 16 Natural Gas Purchase program + Intervention Building reserves Intervention “The Monetary Committee assesses that monetary policy will remain accommodative for a considerable time”

17. Annual Inflation Rate and Inflation Target Negative and low Inflation has become common Source: Central banks & Bloomberg 17 *last available data **The black line represents an IT which the central bank sets as the max limit of inflation

18. Behind the Engine of Growth –Strengths

19. Share of the Population Aged 25-64 with Tertiary-Level Education, 2012 % SOURCE: OECD Education at a Glance 19

20. National Expenditure on R&D % of GDP, 2013 SOURCE: OECD. 20

21. Israel is Leading in International Innovation Rankings Source: World Economic Forum 2015& Bloomberg 21 Factors in Israel that encourage innovation Quality universities that provide the economy with human capital, scientific aptitude, and technological abilities Collaboration between the universities and industry Government support for commercial R&D Developed venture capital industry Ranking Index

22. 22 SOURCE: Eurostat, OECD, BOI, CBS (Israel) Productivity Gap—Israel vs. OECD Average, and Exports’ Share of Output in Israel, by Industry, 2010

23. Long Term Challenges

24. Output per Work Hour 1981–2014, $ PPP, 2014 constant prices $ SOURCE: The Conference Board Total Economy Database, May 2014 Israel OECD USA 24 Israel-USA Gap

25. 25 Productivity Gap—Israel vs. OECD Average, and Exports’ Share of Output in Israel, by Industry, 2010 SOURCE: Eurostat, OECD, BOI, CBS (Israel)

26. Gini Index 2012, at disposable income, post taxes and transfers SOURCE: OECD 26

27. Competition in the Financial System

28. 28 The Israeli Financial System The Banking Sector  Conservative management of banks  High level of services  Tight and meticulous consumer and prudential supervision and regulation  During the GFC the banking sector performed well  Limited competition in credit to SME’s and households; strong competition in credit to corporates and in mortgages Non-Bank Entities  Rapid development of corporate bond market prior to the GFC  Fast increase of direct lending by institutional investors  During the GFC the primary corporate bonds market froze and debt restructuring became frequent  The regulation lagged behind

29. Business Sector Total Credit: 819 billion ₪ Distribution of Credit Sources by Sector 29 * 11/2015 data Source: BOI

30. Distribution of Credit Sources by Sector Non-housing Loans Housing loans * 11/2015 data Households Total Credit: 318 billion ₪ Total Credit : 150 billion ₪ 30 Source: BOI

31. Reforming The Retail Segment: The Measures Taken 31 Simplifying the process of switching a bank Opening accounts via the Internet Creating banking “identity card” Setting “fee tracks” and reducing fees for basic bank services Enhancing price transparency (effective interest rates, fees)

32.  Establishing a Credit Data Register & Credit Bureau  Advancing securitization; increasing funding sources variety for SME’s  FinTech; reducing barriers  Encouraging efficiency enhancing measures in the banking system  Based on risk adjusted supervision, introducing lighter regulation on non-bank credit providers The Reforms On the Agenda 32

33.  Increasing the number of participants: Separating the two credit card companies from the large banks and providing protection to the nascent companies; completing regulation of nonbank financing companies (including P2P)  Improving conditions for competition: A more lenient supervision level for entities that do not take deposits, and easing the connection to payment and settlement systems  Empowering the consumer: A technological platform for comparing information  Deposit insurance: Support for overall stability and increasing the competitiveness of small banks Agreed Measures by Committee to Increase Competition in Banking and Financial Services 33

34. Promoting Competition Alongside Safeguarding Stability Expanding the sources of credit to non-bank entities requires tight consumer and prudential supervision – (“shadow banking”) Level of supervision should be risk-adjusted Setting up the Financial Stability Committee will help coordinate and monitor risks and address them early 34

35. Competition in the Financial System - Concluding Remarks  Promoting the agreed-upon steps, based on a long-term perspective of the good of consumers and the economy, will lead to a material change in the level of competition in the financial system  The Bank of Israel will strongly oppose steps that are liable to sow the seeds of the next crisis or to negatively impact consumers or financial stability 35

36. Thank You

37. The Bank of Israel Opposes Measures That Do Not Benefit the Public For example: Prohibiting large banks from issuing credit cards and extending a credit facility will negatively impact competition, reduce credit facilities, and lead to adverse impact on consumers Encouraging consumer credit at the expense of pension funds will adversely impact the public’s pension security 37