Financial stability report - June 2024

The strong resilience of the French and European financial systems during the period of monetary tightening, coupled with the continued decline in inflation observed since December, have increased the likelihood of a “soft landing” for the French and European economies. Against this backdrop, our perception of the risks attached to the French financial system remains stable versus December 2023, although we cannot rule out a deterioration in the macroeconomic or geopolitical environment.

The European Central Bank (ECB) lowered its three key rates by 25 basis points on 6 June, and the pass-through of past rate hikes to non-financial sector loan rates now appears to be complete. Regarding the credit channel of monetary policy transmission, flows of new loans to the non-financial sector appear relatively stable, and outstanding loans are also stabilising, although loan volumes are primarily determined by demand which means that the pass-through of monetary policy to volumes is slower than it is to rates.

Past interest rate hikes are continuing to be passed through to non-financial corporation (NFC) balance sheets. French NFCs’ average cost of debt tends to be relatively sticky as they mainly borrow at fixed rates, which delays the transmission of past rate hikes to their financial situation. However, compared to their Eurosystem peers, who carry a higher share of floating-rate debt, they will also be slower to benefit from any further rate cuts in 2024 and 2025.  

As with any period of uncertainty, the upheaval of the French electoral calendar in June 2024 opened a period of market volatility, affecting French sovereign debt yields and stock market valuations (especially those of financial intermediaries). Owing to the cut-off date for the finalisation of this report, it does not provide an analysis of these recent developments.

Vulnerabilities remain significant for those non-financial agents most exposed to higher interest rates, but the real estate market adjustment is proving orderly

Risks to NFCs are continuing to rise. The number of corporate bankruptcies is continuing to rise and is nearing its long-term trend, although figures vary according to business size and sector of activity. A special chapter in the report focuses on the financial situation of large companies in the face of higher interest rates. Their debt service ratio had already increased in 2023 and should rise even further in 2024 as they gradually refinance their outstanding debt at higher rates. However, this vulnerability is offset by high cash levels, although individual situations are highly heterogeneous.

The marked rise in interest rates since July 2022 has also put pressure on the residential and commercial real estate sectors. Price falls in the residential real estate market, which accounts for the bulk of banks’ real estate exposure, have now become significant. However, the sector is showing signs of improvement and poses limited risks to financial stability, owing to the prevailing household debt structure and macroprudential standards. The correction in the commercial real estate market is proving more substantial and may be linked to structural factors. Nonetheless, the risks posed by the segment remain contained as banks and insurers have limited direct exposure and investment funds have put in place liquidity management tools.

Sovereign risk remains a focus of concern for France in a challenging fiscal environment. The announcement of a widening of the budget deficit and of Standard & Poor’s downgrade of France’s credit rating did not immediately trigger a significant reaction in spreads or sovereign credit default swaps (CDS). However, the environment of uncertainty poses a higher risk to French debt yields – as demonstrated by the recent widening of the OAT-Bund spread. 

Despite the deteriorated geopolitical environment and an uncertain political and macroeconomic context, the high levels of equity market valuations reflect solid corporate results, while risk aversion in bond markets has declined

Risk premia remain very low while the valuations of the main stock market indices stand at historically high levels. However, in France as well as other countries, these valuations still appear to be driven by a limited number of sectors (tech and luxury in France). The current rise in valuations for the US technology sector, driven by optimistic expectations for artificial intelligence, has all the appearances of being a speculative phenomenon; yet an orderly correction is unlikely to pose any real risk to financial stability, especially if it is concentrated on a few stocks. Elsewhere, valuation indicators for French NFC stocks appear consistent with the excellent results posted in 2023, which were boosted by high profit margins in an inflationary environment. 

Consequently, there is still a risk of a disorderly adjustment in valuations, in part due to geopolitical risks and the threat of a macroeconomic deterioration. Geopolitical risks remain high, but, as of June 2024, have not led to heightened volatility, either in commodity or global equity markets. However, new geopolitical shocks could trigger an abrupt rise in risk premia, along with supply chain disruptions and disorderly stock market corrections for those firms most exposed.

Corporate market funding is benefiting from a decline in corporate credit risk aversion among market participants. In particular, corporate credit spreads (between high yield and investment grade bonds) have narrowed, confirming investors’ appetite for NFC debt securities. However, this spread compression essentially concerns lower risk tranches.

Banks and insurers have confirmed their resilience in the face of rising funding costs and non-financial sector risks

Monetary policy tightening in the euro area has not led to a reduction in French banks’ balance sheets – in fact they have expanded slightly over the past two years, in contrast with those of their Eurosystem peers which have shrunk slightly over the same period. New lending by French banks has continued to rise, albeit at a slower pace, financed by higher deposits and by the issuance of debt securities to replace ECB refinancing operations (TLTROs). Despite favourable financing conditions, however, the interest banks pay on their liabilities has risen faster than that earned on their assets, which in part explains the decline in their net interest margins. The specific features of the French financing model have also played a role: as the majority of lending is at fixed rates, the interest banks earn on their assets depends on the speed of loan renewal.
 
French banks’ liquidity and solvency ratios remain well above regulatory requirements, and are higher than in 2023. The average liquidity coverage ratio (LCR) rose to 147% in 2023, well above the regulatory threshold of 100%, helped by the issuance of debt securities. French banks have a diversified financing structure and investor base. The average Common Equity Tier 1 (CET1) ratio also stands above the regulatory requirement. 

The cost of risk remains limited, although there has been a slight deterioration in overall asset quality, notably due to a rise in the non-performing loan ratio on corporate lending. However, the outstanding amount of non performing loans remains low. French banks’ exposure to commercial real estate remains contained and is primarily domestic. Their exposure to leveraged loans also appears to be limited and has declined. Finally, the structure of lending for house purchases in France helps to limit the associated risks for banks.

French insurers confirmed their robust solvency levels in 2023, although there is still some heterogeneity across the sector. Insurers’ average solvency capital coverage ratio remains above regulatory requirements, but declined slightly over 2023 (256% in the first half of 2023 compared with 250% in the second half), mainly as a result of bank-insurers and non-life undertakings. The returns on their investment portfolios are also improving, and unrealised capital losses appear to be more limited. Higher interest rates have allowed their bond portfolios to yield higher income. Against this backdrop, we have also observed an increase in revaluation rates on individual life insurance contracts, with returns rising to 2.6% in 2023 from 2% in 2022. Finally, the rise in rates has triggered limited numbers of policy redemptions. The life insurance segment has been supported by positive net inflows into unit-linked products.

Cyber and climate risks remain key financial stability issues

The number and share of cyberattacks targeting the financial sector are rising, increasing the risk that a financial institution might suffer tail losses. Generative artificial intelligence can be used to create increasingly complex and hard to detect attacks, making cyberthreats the top risk globally for businesses in 2024. At the European level, the entry into application of the Digital Operational Resilience Act (DORA Regulation) in January 2025 should help to increase firms’ resilience. A special chapter in this report looks in depth at the potential benefits and risks of artificial intelligence (AI) for financial stability. In addition to cyber risks, depending on how it is deployed, AI could increase financial market volatility and procyclicality and generate a risk of concentration of market participants. 

As climate risks continue to rise, the Intergovernmental Panel on Climate Change (IPCC) has highlighted the growing vulnerability of populations and ecosystems to global warming. Physical risks (such as natural disasters or extreme temperatures) are on the rise. Supervisors are therefore monitoring financial institutions’ ability to withstand these risks and incorporate them into their risk management strategy. At the level of the financial system as a whole, dedicated stress tests are carried out to estimate the banking and insurance sectors’ exposure to climate risks.