Spanish banks need to preserve capital to cope with a potential deterioration of the economic outlook, the Bank of Spain warned on Friday.

The central bank said that risks to financial stability had increased since its last report on the matter in April.

Though higher interest rates are expected to boost banks' financial margins in the short term, financial supervisors have recently cautioned against risks stemming from the war in Ukraine at a time when recession looms in Europe.

"All this recommends a prudent provisioning and capital planning policy, allowing a short-term increase in profits to be used to increase the resilience of the sector," it said in its semiannual financial stability report.

The central bank expected high inflation in Spain to further pressure economic outlook in coming quarters after it recently cut its growth forecast for 2023 to 1.4%.

Though Spanish banks, including Santander and BBVA , have reported higher third-quarter profits, earnings were overshadowed by higher provisions.

The European Central Bank has also recommended prudence and its top supervisor Andrea Enria appeared to call time on a season of large share buybacks by banks as the economy weakens.

Spanish lenders have been increasing their shareholder remuneration through higher pay-outs averaging 40%-60%, share buy-backs or a combination of both.

"Pay-out ratios of Spanish institutions are not excessive and around the average or below that of the international banking systems, but the recommendation to be prudent is still on the table," Angel Estrada, head of financial stability at the central bank, told a news briefing.

The Bank of Spain also said a recent banking tax proposal would hurt banks' profitability and capital generation over the next two years, in line with the ECB's non-binding opinion. (Reporting by Jesús Aguado; additional reporting by Emma Pinedo; editing by Andrei Khalip)