N° 63 : French banks’ performance in 2015

• In spite of the low interest rate environment and renewed market volatility, aggregate net banking income increased by 7.3% between 2014 and 2015; however, part of this increase reflects sometimes significant foreign exchange effects as well as the impact of own debt revaluations by some groups.

• Operating costs rose 5.8% but the cost-to-income ratio fell 0.9 percentage point (pt) to 66.4% thanks to a larger increase in net banking income; however, after adjusting to exclude the aforementioned accounting effects, the average cost-to-income ratio comes out higher, pointing to an economic environment that is slow to improve, forcing banks to continue adjusting their costs.

• The cost of risk, which had been falling since 2012 and declined sharply between 2013 and 2014 (down 17.8%), picked up again (up 2.2%), mainly as a result of new provisions for litigation or penalty payments.

• All in all, net profit (group share) recovered to EUR 23.7 billion in 2015 (up EUR 9.4 billion from 2014, an increase of 65.9%); after adjusting to exclude exceptional items in 2014, net profit (group share) grew by around 8%.

Furthermore, information available at the time of writing points to continued strong performance in the first quarter of 2016, with credit risk in particular declining significantly. Return on equity nevertheless remains low and falls far short of investors’ expectations, which are probably too high and unjustified in the current environment.

The trend towards healthier balance sheets and a stronger solvency position, already evident last year, has become more established:

• The impaired loan rate fell for the second year running, and the coverage ratio continued to recover, following a trend that began in mid-2010.

• Lending growth accelerated in France and remained well above average in the euro area where, buoyed by the European Central Bank’s proactive stance, it moved back into positive territory in 2015 after a lacklustre 2014.

• All six groups achieved higher “full CRR/CRD 4” Common Equity Tier 1 (CET1) ratios, bringing the aggregate CET1 ratio for the six groups to 12.6% (up 0.7 pt from 2014). Reassessed using more or less consistent principles, the amount of CET1 capital held by French banking groups doubled between end 2008 and June 2015.

• Banks continue to have plentiful liquidity, and all reported liquidity coverage ratios (LCRs) of over 100% at end December 2015. This improvement in LCRs is primarily due to a sharp increase in the proportion of high quality liquid assets (HQLAs) making up the numerator in the ratio.

• Loan-to-deposit (LTD) ratios continued to decline as deposits grew faster than lending in a low interest rate environment (up 6% between December 2014 and December 2015, compared with year-on-year growth of 2% in lending).

In spite of this progress, risks continue to hamper institutions’ profitability:

• Protracted low and even negative interest rates are eroding banks’ net interest margins, which are also adversely affected by the payment of interest on regulated savings. Against this backdrop, banks could be tempted to focus on business areas that are relatively more profitable but also more risky, which could push up the cost of risk in the future. Furthermore, a sharp rise in interest rates could undermine interest margins, since interest received on loans would adjust more slowly than interest paid on deposits.

• The global macroeconomic environment also gives rise to other factors that need to be monitored, including weak growth in emerging countries, falling commodity prices and the consequences of political uncertainty in Europe (e.g. the UK referendum).

• Combined with the implementation of new regulations, these risks could adversely affect banks’ refinancing conditions just as they need to issue significant volumes of eligible debt to meet resolvability requirements.

• Finally, banks are being forced to question their business models, especially in retail banking, which is likely to be faced with very significant adjustments over the coming years. Not only do they need to take into account all the new regulations and counter the erosion of interest margins; they must also face new challenges arising from the digitisation of the economy, including in particular changes in customer behaviour and entry into the market of newcomers such as FinTechs.