“The resilience of French banks at the mid-year stage, demonstrated by dynamic business activities, strong interim results, controlled asset-quality indicators, solid loss-absorption capacity and stable funding and liquidity profiles, was a good starting point as we enter a new economic phase,” said Nicolas Hardy, deputy head of Scope’s financial institutions team.

French banks’ underlying net income was solid in the second quarter, balancing the impact of increased provisions in the first quarter in relation to Ukraine. Sustained lending activities continue to compensate for low rates, as balance-sheet repricing is at an early stage for banks operating in the Euro Area. “We expect banks to sustain loan production for the rest of the year as clients anticipate a further increase in rates,” Hardy said. “Operating revenues were also boosted by the high level of capital market activities and volatility.”

Cost of risk was modest in the second quarter and the first half. Banks continue to expect CoR to stand at its through-the-cycle level. Non-performing loan formation also remains modest although banks have continued to accumulate precautionary provisions on performing loans in the form of management overlays or sectoral provisions, responding to concerns in relation to inflation and energy supply.

Banks are gradually repricing their balance sheets following the revision of ECB rates, although assessing the speed at which this process takes place is complex because of business-model idiosyncrasies, country-specific features and uncertainties about client behaviour on both sides of the balance sheet (i.e. lending and saving).

A number of factors are affecting French banks’ interest-rate sensitivity. “On the plus side, this includes asymmetric repricing of assets and liabilities leading to higher interest revenues and greater pricing differentiation by borrowers; more rapid rate increases outside of the Euro Area benefiting banks with a geographically diversified presence; sustained loan production as clients are keen to lock in the most favourable rates in anticipation of further rate increases; and an end to the wave of renegotiation on the back book of mortgages,” Hardy said.

Hardy also enumerated a series of factors on the minus side: the ECB’s desire to curb loan production through higher rates; the fact that most mortgages are fixed rate so repricing will happen only when new loans are originated. Even then, rates on new loans are capped by usury rates so repricing will be slow. Loan renegotiation, a source of commission income for banks, will disappear.

“Higher rates mean reduced affordability, which will lead to an increase in non-performing loans and cost of risk,” Hardy continued. “Interest-rate volatility is also impacting the valuation of investment portfolios, affecting the French banks’ bancassurance business model; savings rates are moving up much faster than, say, mortgage rates. Rising rates create incentives for clients to switch out of non-remunerated deposits to better remunerated products, increasing the banks’ funding costs. Finally, wholesale funding costs are also repricing more quickly than deposits.”

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