MADRID (Reuters)

The negative effect of lower interest rates on Spanish banks' profitability should be limited and at least partly offset by rising loan volumes, according to the Bank of Spain on Tuesday.

In its semiannual financial stability report, the Bank noted that any downward pressure on banks' margins would be countered by a "more favourable evolution of the volume of activity."

Spanish banks experienced gains when interest rates rose in response to inflation hikes in 2022 and 2023. They increased rates on loans while keeping deposit rates low.

As the trend now reverses, European lenders must adapt to a changing market with falling benchmark interest rates.

In the first half of this year, consolidated net profit at Spanish banks rose 22% year-on-year, improving their return-on-equity ratio (ROE) by 2.2 percentage points to 13.9%.

Net interest income, which is the difference between earnings on loans and deposit costs, increased by 14.5% year-on-year to June, although this was down from a 27% rise in the first half of 2023.

Banks anticipate that lower borrowing costs will enhance lending activity. Notably, loans to the private sector in Spain have shown an upward trend, growing a seasonally adjusted 0.5% from May to August.

The central bank identified the main risks to banks' stability as potential escalations in Ukraine and the Middle East, along with the outcomes of the U.S. elections due to their possible impacts on trade relations.