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French Banks Face Increased Volatility Amid Policy Uncertainty

Parliamentary elections that failed to produce a clear winner have left France facing increased political uncertainty that could translate into a more volatile business environment. Despite that, S&P Global Ratings maintains its expectation that French banks' profitability will improve, albeit more slowly than previously anticipated.

Our view is based on our forecast that interest margins will improve in 2024 and 2025 as French banks' lending rates finally catch up after increases in deposit rates and funding costs over 2023. But in an environment marked by rising uncertainty, customers may be more inclined to postpone investment decisions. This could result in a more significant credit demand slowdown that will make it harder for banks to restore earnings. We are expecting French banks' loan growth to decelerate to a low (but positive) point in 2024, before stabilizing at 2.5%-3.0% annually from 2025. We also expect average real estate prices to continue to decrease in 2024 before stabilizing. Those forecasts could be revised depending on the on events over the coming weeks, which should clarify the outcome of the election, its policy implications, and the likely impact on banks' activities.

Our view of bank profitability is also based on little change to funding costs. This is based on our view that the migration of customer deposits from sight deposits toward higher-paying time deposits occurred in 2023 and that lower European Central Bank (ECB) policy rates would benefit banks' funding costs from June 2024. It is, perhaps, less clear what will happen in 2025 to the current 3% rate on the Livret A (France's tax free, sight savings account), which may be subject to political influence. A change could increase funding costs versus previous forecasts.

We note that French banks' domestic, retail market profits are typically squeezed by both tight margins on housing loans and cost inefficiencies. We will look for market discipline to protect asset margins should liability costs rise, particularly given that French banks' average net interest margins are already low compared to other European countries. Moreover, we will monitor efficiency improvements, which will be key for banks to maintain profitability. Our forecasts for French banks typically include rising general costs, which means profitability improvements over 2024-2026 will rely on income increasing faster than costs. If revenues receive less support-than-expected from a favorable operating environment then cost cutting, particularly with regards to infrastructure, and the realization of synergies through partnerships are likely to return to the agendas of banks' management teams.

Wholesale Funding Exposes France's Banking Sector To Market Shocks

While French banks typically have large customer deposit bases, a substantial portion of their deposits are centralized at Caisse des Depots et Consignations (a state-controlled institutional investor) and therefore cannot be used to finance bank activities. On the positive side, banks do not bear interest costs on those centralized deposits.

Furthermore, large French corporate and investment bank (CIB) activities are mostly backed with wholesale funding. This has long translated, for some banks, into a customer loan-to-deposit (LTD) ratio that is at the upper end of the European bank average (see chart 1) and contributed to their greater dependence on wholesale money markets.

Chart 1

image

The potential impact of wider wholesale funding spreads on French universal banks, such as BNP Paribas, BPCE, Credit Mutuel, Societe Generale, and Credit Agricole S.A., should be limited by the diversification and significant progress already made in their 2024 funding plans.

Secondary market prices suggest the spread on French bank senior notes has widened about 15 basis points (bps), though the extent of that increase will become clearer when banks begin to issue debt in the market. And we will discover over time if the volatility in funding is short-lived or a more permanent upward repricing that could be a durable drag on earnings.

We think pressure, if it materializes, is more likely to be on earnings than on the availability of funding. That is based on our view that:

  • As a starting point, French banks benefit from a stable and diversified funding structure, featuring wholesale financing and retail deposits, and that their very active debt issuance in the first part of 2024 means that they have already realized much of their funding plans for the year. Targeted longer-term refinancing operations (TLTRO) repayments have been gradual and were largely anticipated by French banks, which increased issuance in the wholesale market ahead of repayments. And we believe banks could adapt their funding plans to mitigate funding cost pressures.
  • France's five main banks have robust average Liquidity Coverage Ratios (LCRs) and average Net Stable Funding Ratios (NSFRs), of 153% and 115%, respectively, at the end of March 2024, including due to their reimbursement of TLTRO drawings (see chart 2).
  • French banks benefits from access to funding instruments such as covered bonds and repurchase agreements (repos) that reduce their use of Eurosystem refinancing, for example in repaying the TLRTO. That, in turn, frees up a portion of their assets, which can be deployed to obtain additional liquidity, if needed. The negative impact of the TLTRO repayment, for example, was managed by further issuance and through the use of excess liquidity.

Chart 2

image

Capital Buffers And Diversification Reduce The Risk Of Asset Quality Deterioration

French banks' fundamentals remain sound, with diversified banking and insurance activities and robust balance sheets supporting creditworthiness. A highly competitive market, that includes the presence of strong mutual operators, has tested the viability of business models and led to the exit of several pure-online players, including ING Bank France and Orange Bank. Elsewhere, mutual lenders' capital retention policies contribute to their credit quality via the ongoing strengthening of their balance sheets.

We see limited scope for asset-quality deterioration. This reflects our expectation that domestic nonperforming assets will increase to just 2.8% of total domestic assets by the end of 2025, up from 2.3%. Furthermore, we see very limited credit risk in the banks' sizable residential mortgage portfolios, which also benefit from the protection of an insurance scheme, run by the bank-owned Credit Logement.

However, risks could increase in the event of lower-than-expected economic growth and tighter funding conditions for corporates. We see potential credit risks relating to unsecured lending to consumers, small and medium enterprises (SMEs), professionals, and in sectors such as construction and real estate development--where credit quality deterioration among borrowers at with high interest burdens could weigh on some banks' portfolios.

French Banks Sovereign Bond Exposure Is Limited, But Increases When Insurance Is Included

We estimate France's five largest banks' (Societe Generale, BPCE, BNP Paribas, Credit Agricole, and Credit Mutuel) median exposure to the domestic sovereign equates to about 20% of their common Equity Tier 1 (CET1)--excluding exposure to Caisse des Depots et Consignations. La Banque Postale (LBP) has the highest exposure, due to its large excess retail deposits which are invested in sovereign debt. French banks also hold significant domestic sovereign exposure through their insurance activities. Incorporating banks' insurance entities increases the median exposure to the domestic sovereign in relation to CET1 to about 45%. France Assureurs, an insurance industry association, estimates that French insurers hold about €347 billion of French sovereign debt, though this amount includes exposures related to unit-linked insurance plans. Of that amount, about €67 billion relates to CNP Assurances, France's second largest life insurance company and a fully owned subsidiary of LBP.

We see limited risk of significant withdrawal requests from life insurance products, such as the Fonds Euros, given the current positive life insurance collection trend. As a result, we think the exposure of insurance to market value risk is limited on sovereign bond portfolios. Moreover, France's Sapin II Act, an anti-corruption law, allows the Haute Conseil de Stabilite Financiere (HCSF), a regulatory body, to temporarily suspend withdrawals on life insurance contracts in the event of a serious threat to financial stability. The recent trend has been toward an increase in investment in Fonds Euros contracts due to rising policy rates that have made investment more attractive.

Political uncertainty could also encourage French households to save against future uncertainty. We note that a change to life insurance's tax advantages has not, at this stage, been a target of any political party.

Our View Of Credit Quality Will Remain Unchanged Barring A Significant Deterioration Of Our Macroeconomic Forecasts

We believe our Banking Industry Country Risk Assessment (BICRA) economic risk score of '3' and industry risk score of '4', which lead to an anchor of 'bbb+' for banks operating only in France, appropriately reflect the strengths and challenges of France's banking system and position it fairly against banking sectors in other European countries.

The one-notch downgrade of France to 'AA-' on May 31, 2024, did not affect our view of the French banking system or the ratings and outlooks on French banks (see "Banking Industry Country Risk Assessment On France Unchanged Despite Sovereign Downgrade," June 3, 2024). France's weak fiscal metrics and high government debt limit the government's ability to support the economy, if required, but is something we already capture in our assessment of the economic risks faced by French banks.

On the downside, though, a material downward revision of our macroeconomic forecasts (such as a larger-than-expected increase in unemployment or a large increase in our credit loss projections), or any further negative rating actions on France could alter our view on the credit quality of French banks.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Nicolas Malaterre, Paris + 33 14 420 7324;
nicolas.malaterre@spglobal.com
Secondary Contacts:Francois Moneger, Paris + 33 14 420 6688;
francois.moneger@spglobal.com
Philippe Raposo, Paris + 33 14 420 7377;
philippe.raposo@spglobal.com
Mathieu Plait, Paris + 33 14 420 7364;
mathieu.plait@spglobal.com
Clement Collard, Paris +33 144207213;
clement.collard@spglobal.com
Nicolas Charnay, Frankfurt +49 69 3399 9218;
nicolas.charnay@spglobal.com
Andrey Nikolaev, CFA, Paris + 33 14 420 7329;
andrey.nikolaev@spglobal.com

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