A year of lower interest rates: Is the boom coming to an end for big banks?

MadridNegative or 0% interest rates have been one of the main headaches for Spanish banking for years. The sector has experienced this as a limit to its ability to make money from the banking business (this arises mainly from the difference between what the financial institution pays to obtain money and what it charges to lend it to companies or families). But in 2022, this changed completely.

In the face of rising prices, The European Central Bank (ECB) began to rise interest rates, which opened a peaceful horizon for the sector and its business. Since then, quarter after quarter, The banks have announced record profitsBut now that interest rates have begun to fall, easing the pressure on businesses and households, the romance continues. In the first half of the year alone, the four major banks (CaixaBank, Banco Santander, BBVA, and Sabadell) earned record profits of €16.206 billion. The sector is feeling the impact of the ECB's decision, but has sought ways to protect itself.

When did it all begin?

The ECB began raising interest rates in September 2022, going from 0% to 0.8%. The increase peaked in September of the following year, with rates at 4%. In June 2024, the institution chaired by Christine Lagarde approved a first reduction, and more continued until last Thursday. Given the geopolitical tensions and the ongoing trade war with the US, the ECB has decided to keep them at 2%.

This has a direct impact on banks' net interest income. The main reason is the activity that financial institutions in Spain monopolize: mortgages, corporate loans, and consumer loans. The ECB's rate hikes lead banks to raise their own rates on these products, which translates into an improvement in their margins. Thus, when rates rise, margins soar. Conversely, when the ECB applies a cut, margins begin to shrink.

With the first half of the year's results in hand, we can observe this trend in the case of CaixaBank, Banco Santander, and Banco Sabadell, while the only one that has continued to expand its net interest income is BBVA. This trend occurred in the first quarter of the year (-1.3%). CaixaBank also stands out, where net interest income fell 5.2% to €5.282 billion compared to a year ago.

The main solution Spanish banks have found is to offset this drop in net interest income with an increase in lending volume and other revenue sources such as commissions. During the first half of the year, the four major banks expanded their net income from commissions, with Banco Santander, for example, recording a record €6.684 billion in just six months through this channel. "The fact that rates are falling will influence the performance of lending [...], which encourages us, especially in Spain," reflected Santander CEO Héctor Grisi, in one of the latest earnings presentations.

Regarding the volume of credit, the good performance of the Spanish economy, especially with regard to the labor market, fuels this optimism: people are taking out more loans, primarily for consumer purposes, although mortgage lending and business loans have also increased. Likewise, this is also a consequence of the ECB lowering the price of money (by lowering rates), as this boosts the economy and reinvigorates consumption and investment.

But all of this also leads to a price war for those who manage to sign more mortgages. During the presentation of half-yearly results, Grisi referred to the market having become "a bit irrational." "Some of our competitors have decided to offer mortgages of up to 1.65%. [...] We think these levels must not be profitable for them." BBVA, for example, assumed it had maintained its revenue margin from consumer or SME lending, but not from property purchases, where, in fact, it had seen a drop compared to a year ago. "The market is very competitive. We don't see any point," CEO Onur Genç said on Thursday.

Costs, public debt, and provisions

Cost control is the other factor that explains the offsetting effect of falling margins. Years ago, this had translated into sharp staff reductions, especially after the Great Recession, but now technology has come into play. Banks have opted for digital services, which reduce costs, and have accustomed customers to online banking, allowing them to streamline their branch networks.

Added to this is the purchase of Spanish government debt. In fact, the level of government debt held by banks is at an all-time high. Although their profitability has fallen due to the ECB's decisions, the strategy banks see is that it guarantees them assets that provide long-term stability. They also offset the sales of that debt, through which they record capital gains. They are also reducing their provisions—negative entries in the income statement in anticipation of future losses—which allows them to flex their muscles, although the Bank of Spain has been calling for months to strengthen its solvency and, therefore, have more provisions to face a possible shock, especially at a time of geographical turbulence.

However, there is consensus that rates will not return to 0%. While a normalization is expected after the sharp increase recorded in 2022 and 2023—and the possible drop to 2% in 2026—by 2027 the threshold will return to 2%, according to the latest Bloomberg forecasts.