In addition, low interest rates and, in general, more accommodative financial conditions naturally have a positive impact on economic activity and employment and help stimulate the flow of credit, thus also driving up banks’ profitability. Indeed, this is the key rationale behind an expansionary monetary policy such as that implemented in the euro area in recent years. As an illustration of these effects, according to various ECB  12/29  studies2 and the Banco de España’s own estimates, the set of monetary policy measures adopted since mid-2014 will have an overall impact on real GDP growth in the euro area of around 2 pp in cumulative terms between 2016 and 2020. Moreover, these estimates do not include the measures agreed in September which, according to the Banco de España’s estimates, could add up to 0.4 pp in cumulative terms to euro area GDP growth by 2021. In any event, it is fair to say that there is evidence that, since the ECB’s deposit facility rate fell below zero, negative surprises in short-term interest rates have been accompanied by falls in European banks’ stock market valuations. Given the endogenous nature of the monetary policy response to projected economic developments, this response by bank share prices to monetary surprises may reflect, on the one hand, the negative impact of less favourable projections for the future macroeconomic setting and, on the other, the market view on the direct negative effect of further interest rate cuts on banks’ future profitability against a backdrop of a prolonged period of negative rates.
In particular, lower interest rate levels help reduce losses on credit portfolios, thanks to the favourable effect they have on borrowers’ ability to repay their loans, associated both with lower loan costs and with the higher income and lower unemployment levels linked to the positive macroeconomic impact of lower interest rates. These effects have been especially significant in countries such as Spain where the banking system had a high level of non-performing loans and where short-term and variable rate lending predominates, since this means that changes in market yields are rapidly passed through to the cost of outstanding debt. This effect thus explains part of the decline in the NPL ratio in recent years. In addition, lower interest rates help drive up the prices of financial and real assets. This effect is immediate in the case of debt securities, especially long-term ones, as their prices are more sensitive to yield changes. The prices of equities and real assets, such as housing, are also boosted by lower interest rates, owing to their effect on the discount factor, although these prices are also affected by other factors, such as macroeconomic expectations. All this entails capital gains for banks exposed to these financial and real assets. It also increases the value of loan collateral, which enhances the credit quality of loans and, therefore, reduces losses on the credit portfolio. That said, it is true that these capital gains become exhausted once interest rates cease to decline and remain at low levels.