collapsed differential
The Bank of Spain tracks mortgage loans from banks and asks how new loans priced against a reference rate behave if money costs rise. In recent figures the average mortgage rate sits around 2.91 percent in December and 3.54 percent in March, with the gap to the reference rate narrowing. The supervisor notes that this shrinking differential raises a potential risk for lenders, since tighter margins can erode profitability if asset costs move differently from loan terms. The Bank of Spain affirmed that it monitors asset prices and affordability carefully to ensure stability across the system.
The way mortgage rates are built is through a reference rate plus a margin to cover various costs. What this means for lenders is that any shift in funding costs or borrower risk directly impacts the cost of credit for businesses and individuals. A small but steady differential can support lending activity, but if the gap narrows further and money costs rise quickly, banks face higher risk of losses when macro conditions move away from initial expectations.
Cost efficiency remains crucial in these operations, and the central bank has warned that a dynamic financing environment can expose lenders to losses if they cannot pass higher costs to borrowers. When wholesale financing costs or deposit costs rise, banks may struggle to keep financing affordable for customers. In this context the European Central Bank actions and market funding dynamics play a significant role in shaping the landscape for mortgage lending.
economic signals and lender responses
The Bank of Spain calculates mortgage pricing by using an index known as the issued weighted rate derived from the Interest Rate Swap IRS measure. This index captures the average cost of money at a given maturity and reflects market expectations without a risk premium. Between 2004 and 2022 the median spread between new mortgages and the IRS stood at about 194 basis points. The trend shows a decline from higher levels during the inflation surge to more recent narrower differentials. The bank notes a recent movement where official rates rose faster than mortgage prices, suggesting lenders may adjust more gradually to policy shifts.
Indirectly this dynamic supports a policy stance that wants housing credit costs to move up in step with central bank tightening. The goal is to reduce housing demand enough to ease inflation pressures while preserving financial stability. The supervisory report also points to a temporary loosening of lending standards in some segments, though it expects those easing effects to be short lived.
In practice the guidance indicates that lenders respond slower than market rates when monetary policy changes. The stability of deposits funded by reference rates is relevant because it can influence the overall cost of financing for businesses. If the financing environment tightens more quickly than expected, the cost of debt may rise beyond early projections, and lenders may adjust pricing accordingly. A sharper pullback in bank funding costs could push rates lower than anticipated in certain scenarios, especially for fixed rate loans with narrow differentials.
principles of prudent lending
Extremely low mortgage rates draw in customers and can boost short term volumes, but they carry longer term risks for the financial system. When lenders chase volume without commensurate risk controls, balance sheets can weaken and the ability to lend could be impaired. The Bank of Spain therefore keeps a keen eye on the stability of the sector and the wider economy as a whole. A wider concern is whether the drop in spreads across banks signals a more permissive lending stance in some cases, or just temporary market adjustments.
The report also reflects on the housing market dynamics during the 2022 period, noting that increased risk taking in the real estate sector should be monitored when deposit and credit costs are under pressure. The central bank underscores the importance of maintaining prudent lending standards and aligning mortgage pricing with genuine funding costs and risk, ensuring sustainable credit growth over time.
Looking back to the 2015 to 2016 period, a competitive race for mortgage business led banks to push pricing aggressively as reference rates fell. A later regulation penalized mispriced loans to protect financial health. That history helps illuminate the present situation, where pricing remains linked to reference rates but more closely tied to cost structures, risk, and macro policy dynamics. The current environment is shaped by a mix of policy signals, market funding conditions, and the goal of steady, sustainable lending that supports housing markets and broader economic activity.