The European Central Bank has kept its policy stance firm in the face of stubborn inflation, continuing to emphasize a cautious approach to bank lending. Across July to September, Spanish banks showed signs of resilience, yet tightened lending criteria for a sixth straight quarter dating back to March 2022. Lenders now assess loans with stricter conditions, including interest rates, loan amounts, maturities, and required guarantees. Demand for credit weakened further from January and is expected to ease again in the fourth quarter, though the decline is anticipated to be milder than in the summer period.
A recent quarterly bank credit survey published by the Bank of Spain reflects the ECB’s strategy in action. The euro area central bank has raised reference rates rapidly since mid-2022, lifting the prime rate from zero to 4.5 percent and increasing the deposit facility from minus 0.5 percent to four percent. The ECB also ended substantial debt purchases and urged financial institutions to unwind extraordinary liquidity injections introduced during the pandemic ahead of schedule.
The central aim is to cool domestic demand and pricing pressures by making credit harder to obtain and by reducing borrowing for households and firms. Early signs are evident: the average mortgage rate, which accounts for about three quarters of household borrowing, rose by 2.3 percentage points to 3.436 percent in August from December 2021, when the tightening cycle began. Other loan categories to households rose by just over one percentage point to about 6.94 percent. Consequently, household loan balances slipped roughly 2 percent to around 677.354 billion euros. A similar pattern emerged in corporate lending, signaling a broad tightening across the credit market.
Worsening Picture for Homeowners
The Bank of Spain’s document shows households faced their weakest period in the summer months, with banks applying more stringent lending criteria to family loans compared with April and June. Regulation intensity for corporate loans remained similar to prior periods. The rise in mandatory interest rates was comparable for households and was only slightly more moderate for companies. The ECB characterized the tightening of mortgage criteria as notably pronounced in Spain, more so than in Germany, France, or Italy.
Across banks, loan applications have been increasingly rejected due to higher perceived default risk, tighter risk tolerance, and slower liquidity. Demand for loans generally declined, with a sharper drop in the summer relative to spring and early summer, driven by higher mandatory rates. For households, reduced investment intentions and weaker confidence, along with a dimmer housing outlook, contribute to weaker demand. For firms, prospective investment plans were trimmed, reflecting the broader macroeconomic cooling and rising borrowing costs.
The survey also shows that banks have recognized a clear profitability benefit from higher ECB rates. Higher lending rates boosted interest income, while banks slowed deposit remunerations to conserve funding and shield margins. This combination supported a notable improvement in profitability, with expectations that this trend could extend for several more months. Yet banks caution that higher defaults may necessitate larger loan loss provisions, potentially depressing capital and asset valuations as stress increases in the credit pipeline.
Overall, the credit environment remains challenging for borrowers in the euro zone. Although profitability for banks has improved in the near term, the jury is still out on whether increased provisions and potential asset write-downs will offset these gains in the longer run. Stakeholders should monitor ongoing policy signals from the ECB, the evolution of consumer and business confidence, and the trajectory of housing market dynamics as part of a broader assessment of financial stability in the region.