The Bank of Spain alerts banks to the complex situation and urges them to increase their provisions.

The Governor of the Banco de España, Pablo Hernández de Cos, gave a presentation on 4 October entitled “The new economic scenario for banks”. After reviewing the various economic indicators, the Governor stated that “the potential impact of the current climate of uncertainty on the banking sector calls for extreme prudence“. For Hernández de Cos, while gross margin will increase in the short term due to the rise in interest rates on both new and existing variable-rate loans, funding costs (deposits and debt instruments issued in the financial markets) will also be pushed up.

The Governor warned that “the adverse effects of the current and foreseeable environment on the ability of households and firms to meet their financial obligations will manifest themselves mainly over a longer horizon (one to two years ahead)”. As a consequence, banks will have to increase their provisions to cover potential losses.

The latest Financial Stability Report, published in May 2022, includes simulations of the impact on banks of a scenario in which some of the current risks materialise: additional energy price hikes and more persistent bottlenecks in global trade, leading to further spikes in inflation and a further tightening of monetary policy, together with a deterioration in agents’ confidence and increased risk aversion. The results show that the sum of the different transmission channels in these stressed scenarios would generate a negative impact on bank solvency of between 1.8 percent and 3 percent for Spanish banks as a whole. By component, while net interest income would increase, the deterioration in the credit quality of loans to the private sector would lead to greater losses. Moreover, the simulated rise in interest rates entails a slight reduction in the value of bond holdings on banks’ balance sheets.

Hernández de Cos concludes that we are in the midst of a very complex macro-financial situation, characterised by high inflation, tighter financing conditions and heightened uncertainty, which has already led to a slowdown in economic activity in the third quarter and a general downward revision of growth prospects for the coming quarters. In this context, although the starting point for the banking sector is positive, extreme caution is needed and risks, which can worsen rapidly, need to be closely monitored and new stress scenarios need to be envisaged. All this leads the Governor to recommend banks to be very careful in their provisioning policy and capital planning in the coming quarters.

The consequence for companies seems clear: further credit tightening by banks and a rise in the financial cost of their debt. Expanding the number of non-bank financial providers and seeking more liquidity in anticipation of this tighter scenario seem sensible advice at this point in time.