Financial institutions in Spain and across Europe are being urged to strengthen their credit quality frameworks as a response to mounting uncertainty. The Bank of Spain’s supervisory authority has warned for months that a predictable rise in loan impairment and a potential drop in asset values could slow economic activity. On a recent occasion, Margarita Delgado, the second in command at the bank, underscored the need for robust capital, higher provisions, and disciplined credit policies. She stressed that the current climate demands vigilance, warning against any complacency as institutions navigate heightened risk.
Speaking at a conference organized by the banking union AEB, Delgado based her critique on two key data points. First, loans under special supervision—characterized by elevated default risk, amounting to 9.29 percent of total loans in the euro area—have declined from their peak in late 2022. This trend heightens the importance of early warning systems that can detect deterioration in economic and financial conditions before it translates into widespread distress. In the current environment, a slowdown in the economy could increase the share of overdue debt, or at least its weight in total lending, she warned.
The second point highlighted is the sizeable drop in refinanced credit within the Eurozone, which fell to 17.8 percent by June. This shift stems largely from many refinanced loans being reclassified into regular loan categories. Delgado asked whether these changes reflect stronger job markets and more robust business activity, or if they signal a lasting impact from higher interest rates. She noted that this development matters for the overall assessment of credit quality as the year closes, especially in a context of weak growth, persistent inflation, and rising geopolitical tensions.
Profit threatened
Delgado also argued that European Central Bank interest rate hikes aimed at curbing inflation have generally helped banks’ profitability. She explained that the higher cost of money tends to affect loans more quickly than deposits, though defaults and provisions have not yet fully adjusted. The cost of risk, measured by provisions relative to loan balances, fell from 0.52 percent to 0.45 percent within a year. Banks in Spain saw a larger increase in basic income compared with the euro area average, with profitability reaching roughly 12 percent, even as higher provisions tempered the gains.
However, the near-term outlook remains uncertain. Delgado warned that the recent margin increases from tighter monetary policy are unlikely to be sustainable in the short term. Spanish banks have passed roughly half of the rate rise to borrowers, while only about a quarter has shown up in household term deposits and less than half in corporate term deposits. Deposits still exceed loans and other forms of funding, which could shift as liquidity conditions evolve and funds flow through the system. She cautioned that liquidity could tighten further as systemic liquidity declines.
Looking ahead, the likelihood of further asset quality deterioration will depend on the broader economic trajectory and labor market performance. Delgado called for stronger credit risk management, with a focus on early warning systems to anticipate potential increases in defaults and to support more efficient portfolio adjustment in times of uncertainty. The message was clear: careful risk governance and proactive stress testing are essential to maintaining resilience in the banking sector through an environment of uneven growth, elevated inflation, and shifting external risks.