Changing the engine: The interest rate party is ending, but banks are still managing to profit

As with the weather, so it is with macro data: it is hard to put a finger on the exact moment when conditions change, until the moment arrives when it is clear that we are already in a new season. In the past week, there was no room for doubt: the banking spring has ended, or in other words, the banks are in a new environment where the falling interest rate and moderating inflation make it much harder to make money from money. But they are still succeeding.

Four of the five major banks — Leumi, Hapoalim, Discount, and First International — published their financial reports for the second quarter this past week, and tomorrow Mizrahi-Tefahot will close the banks' reporting season. Although two banks — Hapoalim and First International — recorded a decrease in net profit, when neutralizing the special tax imposed by the state on the banking system in the amount of 3 billion shekels in 2026, they show an improvement, even if moderate, in the profit line. The main exception is Bank Leumi, which presented a record profit for a bank in Israel of 2.83 billion shekels. In addition, except for Leumi and Discount, the return on equity in the banks has eroded, but it is still a high double-digit return of 15%-16%, which a decade ago banks could only dream of.

Looking at the banks' results as a whole, here are three prominent points:

1. The banks pressed the gas pedal on credit portfolios in the last quarter. The banks continued to provide credit at an accelerated pace. Standing out above all is Leumi, whose credit portfolio — the largest in the system — grew by 9% since the beginning of the year, thereby meeting the annual target set by the bank for 2026. Compared to the corresponding quarter, Leumi's portfolio grew by 15.8%, Hapoalim's by 14.3%, Discount's by 9.8%, and First International's by 20.1%. What is impressive is the ability to grow at such a pace while maintaining credit quality indicators. The ratio of non-performing loans (NPL) remained low: 0.40% at First International, 0.45% at Leumi, 0.50% at Hapoalim, and 0.53% at Discount.

2. The acceleration in credit was only enough to prevent damage to interest income. The growth of the banks' credit portfolios provided an illustration of the expression "full gas in neutral." In the case of Leumi and Hapoalim, a 14%-16% growth in the portfolio translated into a negligible increase of 0.6%-0.7% in interest income. For Discount and First International, portfolio growth was not enough, and interest income decreased by 4.3% and 7.6% respectively. This is an illustration that the banks, which year after year presented record profits thanks to the rise in inflation and the subsequent rise in interest rates, are dealing with a new macro environment where the interest rate has dropped from 4.5% in the corresponding quarter to 3.5% as of July.

3. The banks' answer: commissions, investment arms, and personnel efficiency. The compensation came from three main engines: First, expansion in non-interest income and investment arms. Bank Leumi recorded a 39.4% jump in these revenues to a level of about 2 billion shekels per quarter. Second, the increase in commission income. Commission income at Discount rose by 7.8% (to 567 million shekels), at First International it jumped by 9% (to 473 million shekels), and at Leumi a 2.8% increase was recorded (to 1.04 billion shekels). The third engine is operational efficiency. Banks are continuing to implement voluntary retirement plans, which allow them to optimize salary expenses and maintain high profitability.