Geopolitics and Israeli Banks: A Systemic Risk Unfolding

As Israel journeys 2025, its banking sector faces mounting systemic risks not just from the prolonged Gaza conflict, but also from escalating tensions with Iran and Syria. The economic and financial fallout from these conflicts has amplified vulnerabilities across multiple sectors, slowing GDP growth, increasing credit risk, and straining financial stability. At the same time, domestic political instability, currency pressures, cyber threats, and shadow banking risks add further layers of concern.

While Israeli banks have demonstrated resilience in some areas, the combination of geopolitical instability and economic fragility raises pressing questions: Can Israeli banks withstand these compounded shocks, or are they inching toward a full-scale financial crisis?

Geopolitical Tensions and the Downgrading of Israeli Banks

The war in Gaza has already slowed Israel’s economy, with GDP growth stagnating at 2.2% in 2025 after an anemic 2024. The banking sector’s exposure to real estate, which makes up nearly 25% of loan books, as well as small businesses and the tourism sector, has heightened credit risk and increased asset quality deterioration. [https://www.maalot.co.il/Publications/SR20250128113853.pdf].

However, the situation has deteriorated further with regional escalations. Iran’s backing of militant groups in Gaza, Lebanon, and Syria has fueled uncertainty, leading to cross-border clashes with Hezbollah and renewed airstrikes in Syria targeting Iranian weapons shipments. Iran has also threatened economic retaliation, including cyberattacks on Israeli banks and potential disruptions to international financial flows.

Credit rating agencies have responded decisively. Moody’s downgraded five major Israeli banks from A3 to Baa1, citing heightened geopolitical uncertainty. S&P Global Ratings followed suit, revising Israel’s economic risk assessment and lowering multiple banks’ credit ratings.

Investor confidence has taken a major hit. Foreign direct investment has slowed significantly, as global investors now view Israel as a riskier financial environment. The Tel Aviv Stock Exchange has struggled, with banking stocks underperforming amid fears of a prolonged, multi-front conflict. Capital flight is becoming a concern as high-net-worth individuals and foreign institutions shift assets abroad, further pressuring bank liquidity.

Stress Testing and Capital Adequacy: Are Israeli Banks Prepared?

The Bank of Israel and the IMF have conducted stress tests simulating a scenario where regional tensions escalate into a wider war. The findings are concerning: Israeli banks are particularly vulnerable to credit risk exposure from large borrower groups, primarily in real estate, tourism, and manufacturing. Bond market volatility could also lead to losses on sovereign and corporate bonds, while sustained capital outflows could trigger liquidity crunches.

Despite these challenges, Israeli banks have maintained stable capital buffers. The tangible common equity to risk-weighted assets ratio remains between 10.2% and 12.3%. While this is sufficient for normal economic conditions, it is moderate by global standards. If the Iran-Syria-Israel conflict escalates, these buffers could erode quickly, forcing the government and regulators to intervene.

Mitigating Real Estate Sector Risks

The real estate sector has become one of the most fragile components of the Israeli banking system. Loan books heavily weighted toward commercial and residential real estate pose significant default risks, particularly as interest rates remain high and demand slows.

Banks have responded by tightening lending standards, increasing provisions for loan losses, working with regulators to monitor high-risk borrowers, and offering deferral programs for struggling homeowners and businesses.

However, these measures do not eliminate the fundamental risk: if real estate values decline amid prolonged instability, banks will suffer significant collateral devaluation. Iran’s recent threats to disrupt Israel’s economy, coupled with continued missile strikes from Hezbollah, have driven down investor confidence in commercial properties. Developers and foreign investors are postponing major projects, worsening the real estate outlook.

Currency Depreciation and Inflation Risks

The shekel has been under pressure, and prolonged conflict could lead to further depreciation. However, there are signs of the sheken becoming stronger over the past month or so. A persistent weaker shekel would increase import costs and inflation, raising the cost of everyday goods. It would also raise borrowing costs for Israeli companies, impacting banks’ loan portfolios and complicating monetary policy. If interest rates rise too quickly, loan defaults could increase, leading to bank losses. However the central bank may be signalling interest rate cuts? [https://www.reuters.com/world/middle-east/israel-central-bank-chief-says-1-2-rate-cuts-possible-2025-if-inflation-2025-01-22/].

Cybersecurity Risks: A Financial Warfare Front

With Iran and Syria involved, cyber warfare has become a critical financial risk. Israeli banks are now prime targets for Iranian and Hezbollah-linked cyberattacks. A successful cyberattack could freeze banking operations, preventing withdrawals, disrupt ATMs and online banking, causing public panic, and trigger a bank run, worsening liquidity risks.

Israeli banks have invested heavily in cybersecurity, but no system is completely secure. If Iranian-linked hackers breach financial networks, the psychological impact alone could destabilize public confidence in the banking sector.

How Does Israel Compare to Other Conflict-Impacted Economies?

Israel’s economic and banking sector challenges now resemble other countries experiencing prolonged geopolitical instability.

• Ukraine: War-driven financial instability has weakened Ukraine’s banking sector, though its international aid buffers help maintain some stability.
• Lebanon: Once considered a regional financial hub, Lebanon’s banking collapse has been exacerbated by political uncertainty, capital controls, and severe currency devaluation.
• Turkey: Periodic economic shocks, inflation, massive depreciation of Turkish lira and geopolitical tensions have strained the Turkish banking sector, though it remains more insulated than Lebanon.

Unlike Lebanon, Israel’s regulatory framework and advanced financial sector provide some insulation. However, the longer the conflict persists, the closer Israel moves toward financial pressures seen in these economies.

Government Intervention: A Short-Term Fix with Long-Term Risks

The Bank of Israel has implemented loan deferral programs, allowing businesses and individuals affected by the conflict to delay repayments for up to six months. While this offers temporary relief, it risks masking deeper financial problems that could surface once the deferral period ends. [https://www.boi.org.il/en/bank-of-israel/iron-swords/boi-outline-banks/].

Additionally, the Israeli government has signaled its willingness to support systemically important banks if needed. While such intervention would prevent a short-term financial collapse, it raises serious fiscal sustainability concerns. Increased government borrowing could inflate public debt, making future credit more expensive. Rising military expenditures due to Iran-Syria threats could divert resources from economic stimulus efforts. Sovereign credit rating downgrades could raise borrowing costs, further squeezing public finances.

Reliance on government intervention also poses a moral hazard risk, as banks may take on excessive risks under the assumption of future bailouts.

Conclusion: A Precarious Balancing Act

The combined impact of the Gaza war, Iranian threats, and Syrian tensions has exposed deep vulnerabilities in Israel’s financial system. While banks have maintained relative stability, risks are mounting rapidly.

With geopolitical instability, credit risks, cyber threats, inflation, and capital flight all in play, Israeli banks are walking a tightrope. The coming months will determine whether they maintain stability or if deeper turmoil awaits.