“We expect French banks to be resilient through the cycle,” said Nicolas Hardy, executive director in the financial institutions team of Scope Ratings, in a report out today. “But while banks are being projected as part of the solution, policy measures are not neutral on banking as a business. Pre-crisis issues have not disappeared. Solutions implemented to relaunch the economy are even accentuating them.

French GDP declined by 13.8% in the second quarter after a 5.9% contraction in the first quarter. French banks withstood the initial lockdown and its immediate aftermath well. Hardy believes they should prove resilient to the uncertain operating conditions, given that they continued operating during lockdown, their financial soundness has improved since the last crisis and because stimulus measures to relaunch the French economy are intended to facilitate a vigorous V-shaped economic recovery.

French banks displayed resilient capital ratios at the end of the first half, while non-performing loan ratios stood well below their end 2018 levels. But first-half net profits fell significantly year-on-year owing to pressure on operating revenue and rising cost of risk. Results varied widely mainly because of sector concentration in intrinsically more volatile corporate and investment banking (CIB) activities.

The cost of risk rose significantly in the first half but from a low level. “If banks were to provision 30% less in the second half, given the expected economic rebound, it would still represent close to 2.5x 2019 levels for the full year,” Hardy said, “or 50bp-60bp in aggregate, which is manageable.”

Among support measures put in place, banks have been asked to make extra efforts to finance the economy. The boost comes from the EUR 300bn State-guaranteed loan programme (PGE; prêts garantis par l’Etat) for corporate working-capital needs. Banks are playing a major role in distributing these loans. As of July 31, a total of EUR 116.6bn of lending facilities had been granted.

Support measures appear successful so far. “At this early stage, we do not observe a material spike in problem loans in France,” Hardy continued. “NPL ratios are stable but loan volumes have also increased. But with the uncertain macro prospects, operational issues and exceptional support measures, banks are navigating a blurred economic reality. Intrusive support measures create a disconnect that could lead to a delayed recognition of problem loans.”

In the meantime, interest revenues are increasingly being squeezed. Corporates have switched to short-term working capital facilities, at low rates. Housing loan production is holding up well, also at low rates, with no sign of repricing. Precautionary savings in the form of sight deposits are on the rise across the board.

There is little leeway for banks to address the revenue challenge. One solution is to reduce the cost base. The reported operating expense base fell 2.5% on average for the five largest French banks in the first half compared to the same period of last year. Lockdown helped on that front but dealing with costs needs to be a permanent feature. Revenue diversification will not happen overnight and, with the global spread of the pandemic, geographic diversification no longer provides any benefit.

Download the full report here.