French banks may be taking excessive risks to meet revenue targets and may face earnings pressure for years to come because they are underpricing their loans, according to a report by Berenberg on the French banking sector.
The Sept. 5 report said that French lenders demonstrated a willingness to increase lending volumes at unattractive returns, as margins come under pressure in a competitive lending market that is growing at 5% annually. It also said French lenders, notably BNP Paribas SA, Société Générale SA and Crédit Agricole SA had set themselves revenue targets that were "too ambitious."
"We thus see the growth focus of the French banks creating two key risks. Firstly, banks may be willing to compete for lending at uncompetitive pricing, locking in returns below their cost of capital for a long period," the Berenberg analysts said. "Secondly, banks may be taking on excessive risks to meet their revenues targets, which may lead to higher loan losses in years to come."
With regards to the French retail banking market, lenders were chasing market share particularly in mortgage lending so they can cross-sell insurance and saving products to customers to offset weak margins. However, given that French mortgages are at fixed interest rates and last more than 15 years in general, banks are facing earnings pressure "for a number of decades" because lenders may be underpricing loans, the report said.
Limited scope for cross-selling
They were also taking a risk by cross-selling high fee generating insurance products to mitigate weak lending margins because the scope for selling such products over the long term was limited. Revenue from such products as a proportion of overall domestic retail revenue at French banks hit a peak of 14% in 2017, compared to 10% in 2009, the report said.
In addition, technological changes and competition from non-banks as traditional branch banking fades could also put pressure on the sale of insurance products, as might regulation to improve price transparency and protect consumers, the report said.
Given weak revenue growth in France, which Berenberg expects to be flat in 2018, the report said that French banks have played a significant role in the expansion of emerging market debt in recent years. The report said that SocGen, the most exposed of the major French banks to domestic lending, had tripled its emerging market exposure since 2009.
"With growing concerns on emerging markets following mounting trade war tensions and the ongoing unwind of the Federal Reserve's balance sheet, this is an area of risk that must be carefully watched, in our view," Berenberg analysts said.
The report also said that French banks are "significantly" undercapitalized, with their capital ratios "comfortably at the bottom end of global peers." It also said French lenders are too reliant on leverage, which is "unsustainable in the context of political and regulatory pressure to end too-big-to-fail banking, as well as a growing distrust of banks’ ability to fairly calculate their required levels of capital."
French lenders are unlikely to build capital through share issues and would have to boost capital buffers by closing capital-intensive businesses and restricting growth in risk-weighted assets, which would put pressure on earnings. Berenberg said it had calculated a capital shortfall of €5 billion for SocGen and Crédit Agricole, or 1.4% and 1.6% of respective risk-weighted assets — or the minimum amount of capital a bank must hold to reduce the risk of insolvency — while at BNP Paribas it estimated the shortfall of €7 billion, or 1.1% of RWAs.
Under new post-crisis rules from the Basel Committee on Banking Supervision, banks will have to hold at least 72.5% of the capital against risky assets recommended by standard models, and the Berenberg report said the new rules would likely have a "significant" impact on French lenders because of their high leverage, especially in the corporate and investment banking businesses, estimating a 100 to 200 basis point hit on lenders' common tier one equity ratios.