Assessment of Risks to the French Financial System Assessment of risks to the French financial system – December 2019

The Banque de France publishes a semi-annual assessment of risks to the French financial system, which brings together analyses prepared by Banque de France and Autorité de contrôle prudentiel et de résolution (ACPR - French Prudential Supervision and Resolution Authority) staff. This offers a way for the Banque de France to share its analysis of France’s current situation in terms of financial stability. The report is also used to support binding macroprudential measures that the Governor of the Banque de France recommends to the HCSF for adoption.

The assessment presents risks to the French financial system in three main categories: risks linked to the macroeconomic environment, risks to financial institutions and market risks. These various risks, which may be connected, are set against a low interest rate environment that presents the financial sector with structural challenges, including the quest for profitability and challenges relating to technological innovation.

In the second half of 2019, the main risks to the French financial system are:

1. Risks linked to private sector debt:  The debt of non-financial agents (non-financial corporations, households) is rising faster than economic growth, given that low interest rates encourage borrowing. The debt to GDP ratio of the total private non-financial sector has continued to rise – by more than 45 percentage points since the end of 2000 – reaching more than 133% of GDP in the first quarter of 2019. Possible shocks – such as an economic downturn or an increase in interest rates – could weaken the solvency of companies and households and the financial institutions that finance them.

2. Risks linked to the interest rate environment in Europe: The persistently low or even negative interest rate environment, justified in the light of the economic situation, has an impact on financial intermediaries. Lower interest rates and flatter yield curves are weighing on banks' net intermediation margin. In addition, gross lending margins have tightened in certain segments where competition is fierce. Insurance companies are doubly affected by the fall in interest rates: in addition to falling returns on their asset portfolios fuelled by lower bond yields, they have to cope with a revaluation effect on their long-term liabilities (in particular in life insurance).

3. Markets risks: Further financial asset appreciation since last June does not appear excessive with regard to the falling interest rates. However, narrowing corporate spreads could result in a correction. Against this backdrop, French institutional investors' appetite for alternative and less liquid asset classes is increasing, even though the structure of their portfolio holdings has not yet been significantly adjusted. This diversification, which is in principle welcome, must be monitored to avoid excessive risk taking.

4. Risks linked to structural changes in the financial system: These changes reflect underlying trends of growing magnitude, which need to be identified more clearly: the development of non-bank intermediation, the digital revolution, the emergence of new risks (cyber-risks, financial risks related to climate change). Although these risks are gradually being identified and understood, the process is incomplete. The fact that they are still insufficiently acknowledged is a factor of fragility per se