MONDAY, 24/06/2024 - Scope Ratings GmbH

French banks: uncertain policy agenda casts shadow over drive to improve profitability

Heightened policy uncertainty in France and the threat of political instability after parliamentary elections have exposed the country’s banks to significant market volatility and challenged their ability to improve profitability relative to peers.

By Nicolas Hardy, Deputy Head, Financial Institutions

Prolonged political uncertainty leading to stalling economic growth in France (AA/Negative) could herald a more difficult period for large French banks, even though they currently display solid credit fundamentals. The French banking sector is mature and consolidated; regulatory oversight limits risk-taking strategies; asset quality is under control; and the large French banks have diversified business profiles, meaningful market shares, and comfortable loss-absorption buffers.

These all support their long-term resilience beyond short-term profitability pressures. The banks’ ability to compensate for margin pressures through business or geographic diversification has been key, if uneven.

Owing to the specific characteristics of the French market, French banks have missed out on retail revenue gains compared to European peers, which have benefited much more materially from higher interest rates. French banks have large fixed-rate mortgage portfolios on the asset side and a higher proportion of repricing liabilities. Their net interest margins have remained among the lowest across European banks since June 2022, when interest rates started to increase.

The banks have guided to a slow repricing of their balance-sheets, which they expect to become more visible in the second half of the year. This would be a late development compared to peers that have a larger share of variable-rate loans, but a positive one nonetheless at a time when net interest margins at most other European peers have likely already peaked.

Meanwhile, we view the possibility of a prolonged period of high interest rates as a material risk factor because of its potentially negative effect on lending dynamics. This is already noticeable in the property market. The prospect of higher-for-longer interest rates will potentially slow economic momentum in France and across Europe for the rest of 2024.

We believe a scenario of muted loan production is even more likely in France because of the compounded effect of the new political realities and the inevitable wait-and-see attitude. The high degree of political polarisation and fragmentation, which the forthcoming parliamentary elections could crystallise, poses questions about the short-term ability of any government to implement structural reforms and consolidate public finances.

This may have severe adverse consequences on short-term lending and business dynamics in France, potentially putting on hold investment decisions by individuals and corporates and affecting the availability of credit.

Weakening public finances and policy uncertainty are also forcing sovereign bond spreads wider. Shift in benchmark rates have a ripple effect on the cost at which banks can refinance themselves in the capital markets and negatively impact portfolio valuations. Market volatility has eased in recent days but is likely to be a feature of the second half of the year. Tapping the market may be unattractive under those circumstances.

Higher risk premiums could erase the benefit of cuts in policy rates. Higher funding costs would certainly add to pressure on net interest margins, although access to normal central bank refinancing facilities is a powerful backstop and an important stabilising factor. On a positive note, French banks were proactive in bond issuance at the start of the year, making significant progress in their wholesale debt issuance plans for the year in anticipation of potential market turbulence.

A major unknown for investors relates to the possibility that some political parties might call for the implementation of populist measures targeting bank profits. Europe has witnessed various political attempts to tax windfall profits. Any initiative on this front, at a time when banks are seeking to improve operational efficiency and catch up with European peers in terms of profitability metrics, could further undermine French banks’ attractiveness for investors.

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