The French financial system is at an increased risk from falling interest rates because of the pressure they are putting on banks' profitability and insurers' solvency, the Bank of France said in its semiannual report on risks to the financial sector.
The central bank raised its risk rating for low interest rates to top place in line with that of rising debt. In its June report, out of four different risks to the financial sector — debt, markets, interest rates and structural changes — interest rates took third place, while debt took first place.
Falling market rates since June imply lower bank profits in the future, while the long-term low interest rate environment is also weighing on the insurance sector, which is seeing a drop in solvency ratios and a lower return on its portfolios, the report said.
Rising debt is also a key risk to the financial sector as corporate and household debt continues to rise, the central bank said. This raises the risk of default among corporates and difficulties of refinancing in case of any macroeconomic shock, it said. It called on banks to be vigilant when granting loans to households, warning against the easing of credit conditions.
The French authorities have been taking action against what they say is a too-rapid growth in loans. The country's High Council for Financial Stability, which oversees the financial system, on Dec. 12 recommended that banks rein in their mortgage lending policies after a 6.7% rise in mortgage lending in October.
The council has previously warned about the fast pace of overall lending growth in France and has twice raised the countercyclical capital buffer to cool the overheating market.
The European banking sector is suffering from low profitability as negative interest rates put pressure on margins. They are also increasing investment in digitization as they face competition from digital banks and fintechs.
The central bank said it continued to see a strong risk from market volatility, mainly in equities, as investors seek greater returns in the low interest rate environment, exposing themselves to greater risk in the event of a market correction.
Its assessment of the risks from structural change remained unchanged from its June report, but noted that financial institutions which do not adapt structurally would be vulnerable over the medium term. Challenges for the industry are digitization, rising competition in the payments space and cyber security, the report said.
Climate change will also be a major challenge for the financial sector, and while large financial institutions have started introducing climate risk in their governance, the whole sector needs to take action, the central bank said.