Digital banks are reshaping the transmission of monetary policy across the euro area, according to European Central Bank (ECB) monetary policy adviser Katarzyna Budnik.

In a recently-published piece of analysis, Budnik found that compared with traditional branch-based institutions, digital banks adjust deposit rates more quickly, while showing a slower response in lending rates.

As banking increasingly shifts to online platforms, the study explained that the way policy decisions affect financial conditions is evolving, with digitalisation altering both funding and lending dynamics.

During the 2022 to 2023 tightening cycle, digital banks reacted more aggressively by raising deposit rates faster and by a greater magnitude than their peers.

This strategy allowed them to maintain deposit inflows, but at the cost of profitability, as lending rates did not increase proportionately.

“Digital banks are faster at adjusting deposit pricing for policy changes, but slower at updating their loan pricing,” Budnik said.

As a result, their interest margins narrowed, reflecting the gap between higher funding costs and relatively unchanged lending returns.

This margin compression translated into weaker lending growth compared with traditional banks, as digital lenders became more constrained.

The blog also highlighted that during the early easing phase in 2024 to 2025, some of these trends began to reverse.

Digital banks were quicker to reduce deposit rates for new customers, which helped restore margins while reducing their previous advantage in attracting funds.

“The big picture is that bank digitalisation strengthens the bank funding leg of the lending channel of monetary transmission,” Budnik said.

The study is based on a dataset covering more than 170 digital banks operating in the euro area between 2016 and 2025.

These institutions were grouped into three distinct business models, namely retail-focused, service-oriented and wholesale-oriented digital banks.

On average, digital banks were found to be smaller than traditional banks, with balance sheets more heavily reliant on overnight deposits and characterised by larger liquidity buffers and intangible assets such as software systems.

They also generate a greater share of income from fees and commissions, in addition to interest income.

Although their overall footprint remains modest, the report noted that digital banks have expanded steadily over the past decade, particularly during the low interest rate environment.

However, the tightening cycle also saw the first instances of digital bank closures, signalling emerging pressures in the sector.

The analysis compared digital banks with similar traditional institutions, focusing on deposit and lending rates as well as funding and credit volumes across both tightening and easing phases.

The findings consistently showed that deposit pricing is more responsive in digital banks, reflecting the lower switching costs associated with app-based banking.

Customers can easily move funds between institutions, forcing digital banks to react more quickly to retain deposits.

“This pattern is strongest for stand-alone digital banks,” Budnik stated, adding that group-affiliated institutions tend to adjust more gradually due to stronger depositor trust.

On the lending side, however, the response was weaker, with loan rates rising broadly in line with peers despite higher funding costs.

This indicates that competition in lending markets limits the pass-through of higher costs to borrowers, particularly for digital banks seeking to expand their customer base.

Another key finding was that price adjustments played a greater role than volume changes during the tightening phase.

Digital banks maintained steady inflows by offering attractive rates rather than significantly increasing deposit volumes.

“Adjustments during tightening occurred mainly through prices rather than changes in deposit volumes,” Budnik said.

Over time, however, lending activity slowed more sharply at digital banks, reflecting the cumulative impact of compressed margins.

During the easing phase, the study found that digital banks again led the adjustment process, cutting deposit rates more quickly than traditional institutions.

This supported a recovery in margins but also reduced their relative attractiveness to depositors.

At the same time, lending rates remained relatively sticky, declining more gradually than deposit rates.

“Lending rates declined more gradually, remaining sticky on the way down,” Budnik pointed out.

The broader implication is that monetary policy transmission is increasingly driven by the funding side of banks, particularly in digitalised markets.

Deposit rates tend to react earlier and more strongly to policy changes, while lending rates adjust with a delay.

This dynamic can amplify the impact of tightening by compressing margins and slowing credit expansion.

The report also highlighted differences between tightening and easing phases, noting that adjustments in deposit rates occur earlier in both cases, but with varying intensity.

From a financial stability perspective, the findings raise concerns about sustained pressure on profitability among digital banks.

“Squeezed margin during tightening can strain profitability and erode market value if sustained,” Budnik stated.

The ECB warned that as digital banking expands, more institutions may face similar challenges, increasing the need for close supervisory monitoring.

In particular, regulators are encouraged to assess the stability of retail funding and banks’ ability to absorb margin pressures, especially in environments of rapid rate changes.

The analysis concluded that stress testing and supervisory reviews should account for these dynamics, as digitalisation continues to transform the banking landscape.