“Political uncertainty in France has raised investor concerns about the potential nexus between domestic sovereign risk and French banks’ creditworthiness. This primarily impacts funding costs, reflected in higher credit default swap levels but we do not consider it an asset-quality issue given France’s sovereign rating of AA/Negative,” said Nicolas Hardy, deputy head of financial institutions.

“But the banks’ and the sovereign’s creditworthiness is sensitive to a more pronounced and sustained economic slowdown. A crystallisation of this risk could lead us to consider that the operating environment for banking activities in France is becoming less supportive,” Hardy cautioned.

Before the elections Scope was already projecting lacklustre 0.8% real GDP growth for France for 2024, below growth potential. Hardy says the large French banks have solid credit fundamentals and can withstand a more pronounced economic slowdown. “As long as the slowdown is temporary, it is unlikely to change our assessment of the supportive operating environment for banking activities in France,” he said.

French banks reported positive momentum in the first quarter although performance for most was below 2023. “The resilience of French banks’ business models lies in their high, albeit uneven, degree of business diversification. The stock of impaired loans increased slightly in Q1 but asset-quality ratios remained robust and in line with through-the-cycle averages,” Hardy continued. On a positive note, there has been no widespread or accelerated deterioration in asset-quality metrics.

The current backdrop will hinder banks efforts to improve their operating efficiency, which is low compared to peers, or to implement strategic initiatives. Indeed, poor operating efficiency remains the main structural credit weakness for French banks compared to peers. French banks’ average cost-to-income ratio was 70.4% at the end of Q1. That was the highest by a notable margin of the large EU/EEA economies and the second-highest of all EU/EEA economies (exceeded only by Lithuania). This compares with an average of 54.6% for the full sample.

Cost-to-income ratios

Adjusted for SRF contributions. Source: banks, Scope Ratings

Meanwhile, net interest margins remain under pressure, particularly in French retail, which is a key driver of French banks’ profitability. Prospects for near-term improvement may be less certain if lending momentum fades.

Download the French bank quarterly here.

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