The tricky economic environment may cause a dip in French banks' net interest income from domestic retail activities. They will need to wait longer to see their revenue benefit from rising interest rates than their banking peers, and the gains may be smaller. What's more, persistently high inflation has crystallized the need to improve cost efficiency. However, in S&P Global Ratings' view, French banks' solid balance sheets and sizable cash buffers will help them to navigate the storm and emerge relatively unscathed. As such, our outlook on nearly all the French banks we rate is stable.

French banks are generally ready for deteriorating economic conditions. First, their balance sheets were unharmed during the COVID-19 pandemic thanks to unprecedented support for the local economy from domestic and European authorities. Second, in the long term, banks' diversified activities and rising interest rates will offset pressures from economic slowdown and inflation. Third, we believe France's large banks have sufficient reserves to withstand rising interest rates and the tighter financial conditions imposed by the European Central Bank (ECB), which could threaten asset quality and liquidity in 2023, and that because loans are predominantly fixed rate borrowers are less likely to default.

Our base case is that France will avoid recession in 2023, although this is by no means certain. We forecast GDP will increase by 0.2% in 2023 (after 2.5% growth in 2022), and unemployment will remain below the 2019 level, stabilizing at 7.9% in 2024. We project that after inflation peaked at 5.9% in 2022, it will slide to 4.4% in 2023 before reverting toward the ECB policy goal of 2.0% from 2024. The French economy has rebounded robustly--both in terms of GDP and employment--since pandemic-related restrictions were lifted. However, the Russia-Ukraine war, commodity supply shortages, and inflation pressure are constraining growth prospects, and risks are now stacked to the downside.

Table 1

Stable Outlooks Signal Banks' Preparedness

Our stable outlook on most French banks encompasses the weakening economy balanced by supportive factors such as the unemployment rate having bottomed out, with only modest future increases expected, and lower inflation in France than other countries. French banks will, however, endure the time lag between the business cycle and banking sector performance. Other hazards include surging credit costs and operating expenses, and the interest rate rise taking more time to benefit net interest income in France versus other markets. In addition, French banks' generally have only modest cost efficiency, when compared with European peers', and inflationary pressures on salaries are likely to be more visible in 2023. Additional synergies and cost reductions will be critical if banks are to mitigate these factors and avoid a reduction in profitability.

We assigned stable outlooks to all the large French banks except for La Banque Postale, to which we assigned a negative outlook following a similar rating action on France at the end of last year (see "France Outlook Revised To Negative On Rising Budgetary Risks; 'AA/A-1+' Ratings Affirmed," published on Dec. 2, 2022; see chart 1).

Downgrades are possible among consumer lending entities. That's why Carrefour Banque, Oney Bank, and Socram Banque carry negative outlooks, which take into account the pressure on their financial profiles or execution risks relating to their transformation plans, which could intensify amid a less supportive macro-operating environment. The escalating cost of living is squeezing budgets for lower-income and some middle-income households. As a result, consumer credit performance could be weaker, as borrowers prioritize mortgages and car loans. In addition, increased refinancing costs and limited scope to pass these on to customers weigh on these business' net income margins. Therefore, we believe the strain on profitability will require consumer lending banks to review their operational setup and strategy in this business segment. During 2023, we will consider the long-term profitability of these banks' business models and their ability to adapt to structural changes to client preference, as well as any advances in delivering their strategic plans.

Chart 1

Chart 2

Stable Banking System Trends

Under our banking industry country risk assessment methodology, we see stable trends relating to both our '3' economic risk and our '4' industry risk assessments (where '1' represents the lowest risk, and '10' the highest). Revenue diversity and existing forward-looking and overlay provisions should continue to support large French banks' profitability in 2023, as they provide a cushion against increasing risks from a worsening operating environment under our current macro projections.

That said, lower economic growth, tighter funding conditions, and persistently high inflation threaten banks' asset quality, business prospects, and cost management. A material downward revision of our macroeconomic forecasts or our credit loss projections could lead us to revise our outlooks to negative from stable. Potential downgrades might come from sustained pressure on a bank's profitability--necessitating a substantial business model adjustment via large restructuring. However, this is not our base case for most French banks, considering the relative positioning of large banks' stand-alone credit profiles (SACPs) and the adjustments banks have been taking since 2020. For some specialized lenders, we could take a negative rating action if we observe weakening business models leading to lower business volumes or more pronounced weaknesses in asset quality, affecting earnings or capitalization.

Revenue Outlook For 2023: Diversity Is Key

Our revenue outlook for this year varies from bank to bank. Rising funding costs as well as slowing credit growth may weaken banks' retail net interest income. Meanwhile, some large banks will benefit from bolt-on or larger acquisitions. Going into 2023, we also expect a high base effect after strong revenue in 2022, resulting from a dynamic increase in customer loans.

French banks will benefit less from rising interest than European peers

In 2023, the gradual rise in interest rates that started in 2022 should boost banks' net interest margins. However, we also expect the cost of deposits to continue rising faster than the repricing of assets. This has a dampening effect on net interest income because banks' assets largely comprise long-dated, fixed-rate mortgages that originated during the previous prevailing low interest-rate environment. This means switching customers to higher rates will be a gradual, piecemeal process. BNP Paribas (BNPP) indicated that by 2025, its net interest income would rise by €2 billion more than it had initially expected in its strategic plan. Therefore, 2023 may be the year that sets the stage for net interest income to rebound fully in 2024 and 2025, if rate increases finally moderate.

So far, we have not seen bank customers migrating from nonremunerated sight deposits to accounts paying higher interest, such as term deposits. Large banks have little incentive to compete more fiercely for deposits, given they would have to offer higher rates while trying to prevent net interest income from declining faster. We will closely monitor whether household deposits shift significantly into higher remunerated savings. If deposit rates were to become more competitive, customers would find it simple to switch savings accounts given their widespread digital access to banks. This would accentuate pressure on funding costs for French banks and offset some of the benefit from rising rates that will eventually materialize.

Challenges specific to French banks

In our view, interest income revenue in 2023 will be affected by the following factors:

A time lag in passing interest rate increases on to customers.   For example, raising rates on housing loans can take more time in France due to the competitive environment--particularly from and between mutuals--and due to delays in usury rate fixing, which cap a bank's ability to pass through all rate increases immediately. Positively for banks, a temporary "technical adjustment" introduced by Banque de France this year allows usury rates to be updated every month rather than every quarter. This is to allow banks to raise their mortgage rates more quickly and to better adjust to refinancing conditions.

The regulated savings rate (Livret A), which has been adjusted upward with inflation.   The Livret A was at 2% at the end of 2022; it will rise to 3% in February 2023 and is likely to be adjusted further above 3% later in the year.

The end of TLTRO.   Banks' revenue will cease to benefit from the ECB's targeted longer-term refinancing operations (TLTRO) program, which provided funding of more than €450 billion to French banks in 2022, following changes introduced by the ECB at the end of 2022.

Chart 3

Loan growth to decelerate to around 2.5%-3.0% a year

Higher rates should curb demand for loans. Additionally, French banks may be less inclined to finance corporate entities to the extent they did in 2022, when many companies favored the significantly cheaper bank financing over market financing.

In contrast, domestic credit increased by around 5% a year before the pandemic, well above the average GDP growth over the same period, demonstrating a gradual build-up of imbalances. A large part of the credit growth during pandemic was from loans guaranteed by the sovereign (around €143 billion), which were granted by domestic banks to corporates and small and midsize enterprises (SMEs), and are now in the amortization phase.

Chart 4

French banks' revenue diversity will fortify them in 2023

Four of the five largest French banks (Credit Mutuel being the exception) run sizable investment banking activities, with BNPP and Société Générale having the largest exposure to the capital markets. We remain cautious about the sustainability of corporate investment banking (CIB) in the longer term, since it is an inherently unpredictable source of revenue. Revenue growth drivers in 2023 for BNPP and Société Générale will likely be fleet leasing activities, through their respective subsidiaries Arval and ALD.

Acquisitions and partnerships that will benefit banks from 2023 include:

• Société Générale's consolidation of Leaseplan.
• BNPP's Floa Bank acquisition and partnership with Stellantis across its operations in Germany, Austria, and the U.K. BNPP will use the proceeds of the BancWest sale to accelerate organic growth.
• Crédit Agricole's strategy in mobility, alongside its partnership with Stellantis in car leasing, and its expansion in Italy with the Creval acquisition.

A concentrated and highly competitive domestic market, but with stable revenue sources for large banks

In 2023, we expect French banks to continue to offer households and businesses lower rates than the European market average and market financing rates for corporates.

We do not see challenger banks as a significant threat; the business models of these niche new players have not yet proved profitable.

Finding Savings Amid High Inflation

As inflation hikes up costs, the need for French banks to make business models more efficient will intensify. Inflation-led cost pressure will be felt in the 2023 results, following salary negotiations; ongoing inflation this year will likely also pressure costs in 2024.

For several years, French banks have been investing heavily in technology to digitalize their information systems, as well as to meet increased compliance and regulatory requirements. They have also looked to develop new personalized services and consequently new revenue sources. Given the need for further productivity gains, banks may be obliged to explore additional avenues of automation and artificial intelligence, and adapt the size and density of their branch networks. A good example is the merger of the French retail networks of Société Générale and Crédit du Nord that closed on Jan. 1, 2023, which should lead to fewer branches and the scaling back of central functions and IT costs.

Sustainability-related initiatives rank high on the agenda

The economic disruption of the energy crisis represents an opportunity to reorient the French economy to make it greener. This will foster a supportive environment for banks to enhance initiatives relating to climate change and energy transition, while addressing the risks to the financial system.

Impairment Charges To Remain Around The Long-Term Average

Despite the weak economic outlook, we estimate that French banks will not see a spike in credit losses (see chart 5). While the depth and duration of a recession in Europe remains uncertain, bank executives are typically assuming a mild recession, with Europe escaping a severe downturn. Between 2019 and the end of the first half of 2022, French banks (BNPP, BPCE, Crédit Agricole, and Société Générale) increased their forward-looking provisions for stage 1 and 2 loans by almost €6 billion. While defaults are likely to materialize in 2023 and beyond, part of these provisions are likely to be used.

Chart 5

We anticipate that SMEs, entrepreneurs, and nonfinancial entities will be squeezed most by inflation and surging energy costs; companies operating in the utilities, chemicals, transportation, autos, building materials, and consumer-driven sectors will be especially vulnerable. Entities unable to pass higher costs on to customers will contribute most to the increase in credit losses. We also consider banks' exposure already classified in stage 2 under International Financial Reporting Standard 9 (see charts 6 and 7), which has remained stable since 2021. Although the French authorities implemented support measures for individuals and small businesses, specifically relating to energy costs, this fiscal support is more targeted and far less extensive than that seen during the pandemic. In addition, the banking sector is exposed to the elevated indebtedness of corporates, which maintain a high level of outstanding net debt. According to Banque de France, two out of every three outstanding loans taken out by French nonfinancial companies pay fixed rates, with 44% of total outstanding loans having residual maturities of greater than five years. Fixed-rate debt and long maturities protect French companies as they are less directly exposed to the consequences of rising financing costs.

Chart 6

Chart 7

Household creditworthiness raises fewer immediate concerns. The housing market is beginning to slow in the wake of interest rate rises and tighter prudential standards. Underwriting standards for housing loans had gradually been relaxed in recent years; France's Haut Conseil de Stabilité Financière (HCSF; the High Council for Financial Stability) has halted this trend. In our opinion, housing loans still present little risk, which is positive as they often constitute a substantial part of the balance sheets of large domestic banks (chart 8). In particular, certain banks have especially large exposures to housing loans, such as Crédit Agricole, Crédit Mutuel, and BPCE. As such, these institutions have a fairly resilient credit profile. A further modest change in housing prices, whether positive or negative, would not significantly increase French banks' cost of risk. Banks' underwriting criteria focus mainly on a borrower's repayment capacity, rather than on property value. As a result, the correlation between house prices, interest rates, and mortgage default rates is weaker than in other markets. On the other hand, fluctuations in the unemployment rate, which we expect will modestly increase over the next two years to just below 8%, have a substantial effect on default rates and, ultimately, the cost of risk on mortgages. These have been extremely low for the past 25 years and we project that they will remain well below 10 basis points (bps).

Chart 8

Like its peers, French banks are exposed to the risk of contagion, via the financial markets, from less supervised counterparties. Market volatility will likely remain high in 2023 and we cannot disregard the possibility that counterparties (such as energy traders, hedge funds, pension funds, and brokers) may default. Last year, defaults were avoided because governments stepped in to provide support.

In our view, some further markdowns on leverage financing and acquisition deals may also occur, as in the third quarter of 2022.

Capital Ratios Stand Firm

We expect French banks' capitalization to remain stable in 2023 (see chart 9). Cooperative groups retain most of their earnings, which in turn helps build up capital. Policies regarding the distribution of capital should remain largely unchanged, including regarding how much a bank's management may consider to be excess capital. BNPP's sale of BancWest will result in a share buyback of €4 billion, but a large amount of the sale proceeds will also be reinvested organically. BNPP's most recently communicated Pillar 2 Requirement increased by a modest 25 bps. Finally, France's HCSF gradually raised the contracyclical capital buffer, first to 0.5% from April 2023 on domestic exposures, then to 1% from January 2024, to strengthen credit institutions' domestic capacity to provide credit along the cycle. Credit Mutuel Alliance Fédérale recently announced it was setting up a "societal dividend" of around 15% of the net income group share, which we assess as having an impact of less than 10 bps on our risk-adjusted capital (RAC) measure.

We estimate that if the operating environment for French banks weakened to the extent that we revised downward our economic score for France to '4' from '3', this would typically affect our RAC by 100 bps, for those banks that have limited geographical diversification.

Chart 9

Protection From Diversified Funding Bases

The universal banking model implies that most French banks rely at least partially on wholesale markets, which exposes the sector to market shocks and higher funding costs. That said, French banks, like many others, entered 2023 with ample liquidity reserves. Funding plans were already geared to replace TLTRO 3 drawings, leading to a strong presence in the market in January 2023. Liquidity coverage ratios (LCRs) at large French banks had been elevated by advances under various long-term refinancing operations--in future, LCRs are likely to be lower than in recent years.

Our high ratings on French banks indicate that we believe they can absorb the funding needed to replace TLTRO drawings and higher costs, thanks to their diversified funding bases.

In our view, wider spreads required by investors could affect French banks' funding costs via contagion if investors' yield spreads relative to other countries, such as Germany, were to widen amid sizable French public debt.

Table 2

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Chart 11

Related Research

• European Banks: Resilient And Divergent As The Economic Reset Kicks In, Jan. 23, 2023
• French Sovereign Outlook Revision Does Not Directly Affect Our Banking System Assessment, Dec. 5, 2022
• Banking Industry Country Risk Assessment: France, Oct. 11, 2022