July 26, 2018

IMF published its staff report and selected issues report in the context of the 2018 Article IV consultation with France. Directors noted that the banking sector is now stronger and has been able to support the recovery. However, vulnerabilities remain, especially related to elevated debt levels in parts of the corporate sector. Directors welcomed the recent macro-prudential measures aimed at reducing imbalances and underlined the need for continued monitoring of vulnerabilities and building bank buffers against shocks, including through the implementation of ongoing international regulatory changes.

The authorities agreed with the IMF assessment. They noted that the French banking system is sound and has improved its capitalization and funding structure, which should help it weather shocks. The authorities concurred with the need to continue to implement ongoing global and EU-wide regulatory changes to further build buffers, noting that French banks are well on track with their minimum requirement for own funds and eligible liabilities (MREL) commitments. While banks have improved financial buffers and supported the recovery, areas of vulnerability remain. The large banks have bolstered capital ratios and maintained profitability in line with peers. However, cost efficiency and liquid-assets to short-term liability ratios are lower than the euro-area median and French banks remain dependent on wholesale funding (including in the USD market), making them vulnerable to maturity mismatches and exchange rate risks. Going forward, the authorities should remain vigilant, monitor risks closely, and build on these measures if warranted. Further actions to incentivize equity rather than debt financing could also be considered. 

Policy priorities include further strengthening financial sector resilience by implementing ongoing international regulatory changes and continuing to use macro-prudential policies pre-emptively. The recent Basel requirements to set output floors for internal ratings-based credit-risk measures and implementation of MREL will help strengthen bank balance sheets. Thanks to a recent law that introduced a new class of senior non-preferred bail-in-able debt, French banks are on track to comply with new EU regulatory requirements. The authorities’ recent decisions to activate macro-prudential measures to prevent the buildup of imbalances are welcome. The decision, effective July 01, 2018, to lower banks’ exposures to large indebted corporates to 5% of banks’ capital is specifically aimed at protecting banks from potential risks arising from over-indebted corporates and at limiting further growth of bank credit to these corporates (this measure has been unique in the Eurozone in addressing such potential risks). Similarly, the authorities’ recent decision to activate a .25% countercyclical capital buffer can help slow down the increase in debt, mitigate incipient systemic risk buildup, and help banks build buffers that could be released in the downward phase of the financial cycle to support activity.

The selected issues report highlights that corporate debt in France has risen significantly since the global financial crisis and is among the highest in advanced economies, reflecting mainly an increase in intercompany loans and bonds. However, the increase in debt is concentrated among large firms with sizable leverage in a few industries, raising questions about these firms’ ability to service this debt when interest rates rise. Stress test scenarios of a large and sudden increase in interest rates suggest that corporate debt at risk could be significant at a macroeconomic level, but that cash buffers would mitigate the impact of the shock on debt service.

 

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Keywords: Europe, France, Banking, Article IV, MREL, CCyB, Macro-prudential Policy, IMF

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