As intended, the European Central Bank tightens monetary policy by closing the credit faucet. The decision to raise interest rates makes loans more expensive and dampens demand. This cooling effect on consumption and investment slows overall inflation. Yet the degree of restraint has surpassed expectations. The Bank of Spain has delayed its forecast about the outlook for bank finances in its latest macroeconomic projections. The maturing loans from the last quarter of 2022 are extended to the third quarter of 2024, representing a 24 month decline. They will then remain largely inactive for twelve months and are unlikely to rebound before the timid improvements anticipated in the second half of 2025.
On the other hand, the auditing authority estimated in March that credit would remain virtually stagnant in 2023 and grow only by mid-2024. In June it revised its forecast, predicting a decline through the third quarter of the year followed by a gradual recovery thereafter. However, the year has seen more deterioration than expected due to higher financing costs and rising uncertainty. The governor Pablo Hernandez de Cos noted that financing conditions are expected to be tighter than previously forecast, driven by higher interest rates and a greater impact on loan offers.
The Bank of Spain now expects the loan balance to be repaid by 2025 at a level about two percentage points above 2019. The forecast rests on information not normally published by the institution, including notional outstanding balances and seasonally adjusted credit. It reflects net flows from new transactions, combined with depreciations, write-downs, revaluations, and reclassifications, adjusted for seasonal loan behavior.
Less supply and demand
The drop in lending stems from both banks and customers, according to the latest Bank of Spain survey on bank loans. On one hand, lending criteria and conditions have kept new loans difficult for five consecutive quarters. Lenders perceive higher default risk and tighter financing conditions, which push them to reject more requests or impose higher costs on those who are approved. On the other hand, demand weakened in the first half of the year mainly due to higher borrowing costs. Companies expect less investment while households grow more pessimistic, drawing on savings and showing weaker housing market expectations.
The rise in ECB rates has been unprecedented in speed and scale: 4.5 percentage points since July 2022. The main rate sits at 4.5 percent, the highest since May 2001. The deposit facility, the rate paid by the central bank on reserves held by banks, reached an all time high of 4 percent. As a result, the average rate for new mortgages in Spain rose from 1.38 percent at the end of 2021 to 3.75 percent by last July; consumer loans rose from 6.1 percent to 8.05 percent, and loans to companies spiked from 1.3 percent to 4.74 percent. Consequently, family loan balances fell by 1.6 percent so far this year to about 679.564 million, while corporate lending contracted about 2.4 percent to 472.147 million.
Less GDP
The Bank of Spain does not attribute the loan declines to ongoing ECB rate hikes alone. It notes that inflation forecasts will be adjusted only if new shocks emerge. The effect period for rate hikes spans roughly 18 to 24 months, with observable consequences on financing conditions, activity, and price levels. The Bank now projects continued credit contraction to weigh on growth more than previously anticipated in June. It expects rate increases to shave roughly 0.6 percentage points from Spain’s 2022 GDP and to trim about 1.2 points in 2024 and 0.3 points in 2025.
This dynamic is not unique to Spain. Financing conditions across the euro area have tightened, reducing both supply and demand for credit. The ECB vice president, Luis de Guindos, described the tightening as real. The central bank reported that total credit to the Eurozone fell by 0.2 percent in August, the first negative reading since January 2015. Private sector lending remained positive but at a slower pace, with households rising by 1 percent and firms by 0.6 percent, marking the lowest growth in years.