The banking sector has dominated the Israeli stock market, not just in 2024 but for several years. Israel has established itself as a powerhouse for profitable banks, consistently delivering strong returns on equity that translate into impressive stock market performance. Banks have been the best risk-reward investment of the past decade. While discussions about increased competition from credit card companies continue, history shows that competition always seems to be "just around the corner" but never fully materializes. That’s likely because the primary mission of the Bank of Israel and the banking regulator is to maintain financial stability, and stable banks are, by definition, profitable banks.

Leumi Bank now sits at the top, surpassing Teva with a market capitalization of 69 billion shekels. The stock surged 52% in 2024 and has already added another 7.8% this year. Its return on equity for the first nine months of the year stood at 17.1%, while net profit reached 7.3 billion shekels, up 41.2% from 5.2 billion shekels in the same period of 2023. CEO Hanan Friedman has successfully widened the gap between Leumi and Bank Hapoalim, with Leumi now valued at about 7 billion shekels more than its competitor. A gap that was once just a few percentage points has now become substantial.

Teva Steps Aside for Leumi

Leumi’s rise to the top is not just about its own success but also about Teva’s recent struggles. Teva more than doubled in value last year, briefly reclaiming the top spot, but a disappointing outlook for the year ahead led to a 20% decline in the stock. That drop placed Teva in second place in market capitalization, trailing Leumi by just a few percentage points. While Teva remains the biggest threat to Leumi’s leadership, for now, the bank holds the crown.

Leumi currently trades at a price-to-book ratio of 1.16, while Bank Hapoalim is at about 1.1. Israeli banks are expected to deliver a 15% return on equity. Even if we take a more conservative estimate of 13%, given their price-to-book multiples, this suggests an implied return of around 11%-12% on market value. That’s an impressive annual return for banks. Of course, risks remain, and the strong earnings seen recently are partly due to the transition away from a zero-interest-rate environment. The expected rate cuts and higher interest paid on public deposits will likely weigh on future profits. However, the banks’ equity continues to grow over time, generating additional returns. So even if return on equity declines slightly, absolute profits may not necessarily fall.

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According to Aviad Sapir, an investment manager at Migdal Capital Markets, "The four key drivers pushing banks forward are interest rates, inflation levels, efficiency measures, and overall economic activity. Looking ahead to the coming year, it appears that Israeli banks will continue to benefit from progress on all four fronts."

Banking Sector Efficiency Continues to Improve

Israeli banks have been undergoing efficiency improvements for years. The number of banks in Israel has dropped significantly over the past few decades and is now quite low compared to other countries. Fewer banks mean fewer players splitting profits and capital, which naturally results in less competition. Meanwhile, banks have been cutting staff and shifting more processes to digital platforms.

Efficiency ratios have also improved significantly. The efficiency ratio, which is calculated by dividing operating expenses by total net interest income and other revenues, has dropped across the banking system from over 60% in 2018 to below 40% today. At Bank Leumi, the efficiency ratio stood at 31.1% in the third quarter of 2024, compared to 32.3% in the same quarter of 2023. Over the first nine months of the year, the ratio was 29.6%, down from 31.4% during the same period in 2023.