France: Selected Issues Paper

International Monetary Fund

doi:10.5089/9781455204755.002.A001

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France

Selected Issues Paper

Author: International Monetary Fund

Publication Date:: 30 Jul 2010

eISBN:: 9781455204755

Language:: English

Keywords:: ISCR; CR; export; France; CDS premium; bank risk; bank CD; ECB bank; bank funding; Corporate bonds; Credit default swap; Global

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The staff report gives details of some selected issues of France, namely its credit developments, systematic linkages of French banks, the need for a significant fiscal consolidation for macroeconomic stability, an update on the developments of France's external competitiveness, and also the evolution of its export performance after the 2008 financial crisis. The report describes these issues in detail, and recommendations are also cited.

Abstract

I. Credit Developments in France and Systemic Linkages of the French Financial Sector¹

A. Introduction

1. This note focuses on two pertinent financial sector concerns in France: (i) credit dynamics in the current recovery period; and (ii) strength and possible systemic implications of the French financial sector’s international linkages. The still depressed growth of bank lending, especially to the corporate sector, raises concerns about a possible credit crunch. Using the bank lending survey, surveys of small and medium–sized enterprises (SMEs) access to finance, and inferences from relative developments in prices of loan and bond markets, the note examines whether the drop in credit growth is driven by demand or supply factors. International inter–linkages of the French financial sector have raised concerns about possible systemic implications of turbulences in international markets. The note analyzes the quantitative importance of financial links to large and complex financial institutions in sixteen advanced countries, and uses bank CDS spreads to examine the risk implications of these systemic linkages under extreme stress. It takes into account nonlinearities of risk dependence and aims to control for all other variables that could affect bank risks.

B. Credit Developments in France

2. Despite relatively less severe consequences of the crisis and an economic recovery starting in the second quarter of 2009, bank credit growth to the private sector has only rebounded slightly. With the French economy falling into recession in the second quarter of 2008, bank credit growth to the private sector plunged from the peak of over 13 percent into negative territory for the latter half of 2009 (Figure 1). In the first quarter of 2010, credit to the economy expanded slightly. Besides, the slight rebound was driven by bank credit growth to households. Bank credit growth to households started to decelerate following the economic recession and dropped below three percent in October 2009. It has rebounded moderately since then (Figure 2). However, bank credit to corporates has continued to contract.

3. Recent developments naturally raise concerns about a possible credit crunch. Recent studies (IMF (2009a, 2010)) argue that a credit crunch is likely to happen after financial crises as a result of bank losses and recapitalization needs, which would constrain bank loan supply. The negative feedback loop between the financial sector and the real economy in turn implies that a credit crunch would weaken economic recovery, especially for economies relying mainly on bank financing.

4. However, separating loan supply and demand factors is notoriously difficult at the aggregate level. A large literature on cyclicality of bank loans has met with limited success in disentangling the two since the demand for loans may fall during recessions because the set of firms relying on bank loans differs from the set of firms that do not. Without comprehensive disaggregated data at hand, the note focuses on presenting some evidence and observations from the substitution between bank and bond financing, the bank lending survey, and surveys on SMEs’ access to finance.

5. Firms are switching from bank loans to corporate bonds. Total credit to corporates increased from 57 percent of nominal GDP before the crisis to 61 percent in the last two quarters of 2009. The share of bank loans in total credit to corporates rose from the pre–crisis level of 62 percent to 68 percent in the first quarter of 2009, but fell to 66 percent in the last quarter of 2009 (Figure 3). The growth of corporate loans dipped into negative territory since the third quarter of 2009 mostly driven by cash credit, while corporate bond issuance started to pick up since the beginning of 2009. Historically, corporate bond issuance has been more volatile than loans. The substitution not only increased the divergence over recent quarters, but also stabilized total corporate financing.

6. Although at first sight the substitution between bond and bank financing seems to indicate bank supply constraints, the change of relative pricing of bonds and loans seems to indicate other possibilities. Since changes in credit demand should affect different types of credit in broadly the same way, the shift from loans to bonds may imply bank supply constraints (Kashyap, Stein, and Wilcox (1993)). However, at the aggregate level, the shift could also be brought about by the redirecting of credit from SMEs to large firms since changes in the financing cost are likely to hurt SMEs more due to information asymmetries (Oliner and Rudebusch (1996)). Given that the financing cost of both bank loans and corporate bonds have come down substantially, it would be useful to look at relative pricing. The ideal comparison would be loans and bonds of similar credit risk and maturity. Without such ideal data at hand, an indicative series of relative pricing measured by composite rates is constructed by comparing the lending rates with bond yields. The substitution reflects the improvement in accessing corporate bond markets (Figure 4), but also seems to be partly driven by the change in the relative cost of loans and bonds. The negative growth of corporate loans happened at the time when the relative price of loan–to–bond bounced off lows (Figure 5). In addition, firms may turn to bond markets for diversification in their financing and tap them on an irregular basis once their financing requirements are met.

7. The bank lending survey provides additional information on bank credit supply and demand factors. The Banque de France (BdF) bank lending survey is comparable to the ECB bank lending survey for the euro area, which was launched in January 2003 and followed the U. S. senior loan officer opinion survey undertaken by the Federal Reserve since 1967. The survey shows the net percentage of opinions for both changes in bank lending criteria and loan demand. Several studies have shown the positive relationship of the survey results with credit developments (Lown and Morgan (2006), Bayoumi and Melander (2008), Lacroix and Montornés (2009), De Bondt et al (2010)).

8. Lending criteria are easing against less declining or rising demand. The BdF lending survey has shown that French banks registered an outright easing for corporate loans to large firms in the third quarter of 2009 and for corporate loans to SMEs in the fourth quarter of 2009 (Figure 6). French banks no longer tightened their lending standards for consumer loans starting from the third quarter of 2009 and eased lending standards for house purchase loans in the fourth quarter of 2009 (Figure 7). The evolution of lending criteria stands in contrast to that of the euro area: the latest ECB lending survey shows that euro area banks are still tightening lending standards on a net basis for both corporate and household loans, although very moderately. Using a bridge model to analyze the French bank lending survey, Lacroix and Montornés (2009) argue that both the tightening of lending criteria and declining demand have led to a slowdown of lending and that demand factors seem to have been more important in the case of corporate lending.

9. While lending standards in France have eased, the degree of easing for SMEs seems to be less than for large firms. In addition, a credit crunch is more likely to take place for SMEs than large firms since SMEs do not have the alternative of financing themselves through corporate bond markets. Without direct SME loan data at hand, we use the ECB survey on the access to finance of SMEs in the euro area (2009, 2010). The survey started in 2009 and provides evidence on the financial situation, financing needs, and access to finance of SMEs in the euro area.

10. The ECB survey on the access to finance of SMEs in the euro area for the first and second half of 2009 seems to show that access to finance for French SMEs has improved and was better than for their euro area peers. Specifically, the survey shows that the availability of bank loans to French SMEs was least negative for 2009 and saw an improvement in the second half compared to the first half of 2009 (Figure 8). In the second half of 2009, 80 percent of the French SMEs reported that they had received the entire amount of the bank loan they had applied for, which was the highest rate among the euro area countries. The rejection rate fell from 12 percent in the first half of 2009 to 7 percent in the second half of the year, which was the lowest rate among the euro area countries. Comparing with expectations six months ago, SMEs in France were more optimistic regarding their access to bank loans in the first half of 2010 than SMEs in the other euro area countries, and on balance expected an improvement in access.

11. This outcome may partly reflect the impact of policy measures taken. Efforts to boost lending to the SME sector and to very small companies have been pursued. The largest five French banks committed to expanding credit to these companies by three percent in 2009 than 2008. The authorities took actions to alleviate working capital shortages by capping payment delays to 45 days, doubling moratory interests and putting in place other legal deterrents to repayment delays. To enhance SMEs’ access to liquidity, especially bank lending, the government has increased guarantee programs run by OSEO so as to allow it to cover up to €8 billion of new loans targeted to SMEs and linked to short–term credits. In addition, to assist SMEs to resolve their liquidity problems by maintaining or obtaining credit, the office of the Médiateur du Crédit was set up in late 2008 and will run until the end of 2010 (Liebert (2009)). The Médiateur du Crédit can intervene at national and regional levels to ease difficulties and help resolve conflicts between firms seeking bank funding and the banks. The rate of successful mediation within 15 days was reported to be 66 percent. The Médiateur du Credit has also helped improve the transparency and functioning of credit insurance.

C. Systemic Linkages of French banks

12. One of the lessons learned from the current global financial crisis is the lack of systemic lens in regulation. Systemic risk is a negative externality imposed by each financial firm on the system. It can be thought of as widespread failures of financial institutions or freezing up of capital markets that can substantially reduce the supply of capital to the real economy. Systemic risk concerns were raised in both the rescue of Bear Stearns and the bankruptcy of Lehman Brothers.

13. This points to the importance of assessing the systemic implications of international financial interconnections. The strong financial linkages arising from the increasing globalization and complexity of financial institutions, instruments, and markets could be a double–edged sword. The interconnections could not only facilitate better credit allocation and risk diversification, but also make the stress in one part of the financial system spread more quickly and widely. There has been a flurry of proposals to address systemic risk (IMF/BIS/FSB (2009), Lepetit (2010)). However, to implement an appropriate package of measures, including capital and liquidity surcharges or financial levies and taxes, an appropriate approach to measuring systemic importance is called for. The assessment could be based on individual bank characteristics such as leverage, asset quality, size, and substitutability; on statistical measures; and on measures of complexity and connectedness that define large, complex financial institutions. Systemic risk depends on the inter–linkages within the financial system and across the various sources of vulnerability, and may well be greater than the sum of the risks facing individual institutions.

14. As the connectedness among financial institutions tends to be nonlinear, nonlinear methodologies need to be used. One of such methods is quantile regression. In contrast to the OLS regression methods, which reveal mean relationships among dependent variables and independent variables, quantile regression reveals relationships among dependent variables and independent variables across different quantiles of the sample distribution. This is particularly useful to analyze codependence during distress periods when systemic risk is more of a concern. Since during distress periods, all variables will display large deviations from the mean, relationships uncovered by the quantile regression corresponding to high quantiles are more appropriate and useful than mean relationships uncovered by OLS regression. Quantile regression was first introduced by Koenker (1978, 2005) and has recently been applied in systemic financial risk studies of American banks (Adrian and Brunnermeier (2009) and IMF (2009b)).

15. This note uses a similar methodology to analyze the systemic connections of major French banks with 41 banks in 16 countries. The French banks included are BNP Paribas (BNPP), Credit Agricole (CA), Societie Generale (SG), and Natixis (NA). The foreign banks included in the analysis are large and complex financial institutions. They are Erste, Raiffeisen (Austria); Fortis, KBC (Belgium); Danske (Denmark); Commerzbank, Deutsche Bank (Germany); EFG Eurobank, National Bank of Greece (Greece); Allied Irish Bank, Anglo Irish Bank (Ireland); Banca Intesa Sampaolo, UBI, Unicredit (Italy); Mizuho, Sumitomo (Japan), ABN Amro (the Netherlands), DNB Nor (Norway), CGD, BCP (Portugal); BBVA, Banco Popular Espanol, Banco de Sabadell, Banco Santander, Bankinter (Spain); Nordea, Svenska, SEB (Sweden); Credit Suisse, UBS (Switzerland); Barclays, HSBC, Lloyds, RBS, Standard Chartered (the U.K.); and Bank of America, Citigroup, Goldman Sachs, JP Morgan Chase, Morgan Stanley, Wells Fargo (the U.S.) An illustration of the nonlinear method is shown in Figure 9. It is clear that when CDS spreads are in the low quantile, (i.e. calm time), the linkage is low; while when CDS spreads are in the high quantile, (i.e. stress time), the linkage is high.

16. The sample consists of daily observations covering the period between January 1, 2004 and May 10, 2010. The dependent variables are five–year CDS spreads of each French bank. The independent variables are five-year CDS spreads of each non–French bank and a set of control variables. These control variables aim to capture both bank–specific and French market–specific risk factors.

17. The control variables are selected based on theoretical and empirical studies in the literature (Fama and French (1989, 1993), Collin-Dufresne, Goldstein, Martin (2001), Xiao (2008, 2009)). To proxy liquidity risk, the bid-ask spreads of each bank’s CDS premium are used. The wider is the bid-ask spread, the higher is the liquidity risk. To proxy general risk aversion, the implied volatility index (VIX) of CAC 40 from the NYSE Euronext is used. The higher is the index, the higher is the risk aversion of the market. As can be seen from Figure 10 below, VIX of CAC 40 moves closely with the VIX of S&P 500 from the Chicago Board of Trade. To proxy counterparty risk in the interbank market, Euribor spread measured as the difference between the one-year Euribor spread over the one-year constant-maturity French treasury yield. The wider is the Euribor spread, the higher is the counterparty risk in the interbank market. To proxy the business cycle, the slope of the French yield curve measured as the difference between 10-year and three-month French treasury rates is used. The steeper is the slope of the yield curve, the more likely the economy is in a upturn. The expectation of future economic performance is proxied by the SBF 250 index return. The higher the return, the lower is the credit risk, as the default risk is a function of the value and volatility of equity and the distress barrier.

The baseline quantile regression is as follows:

Ym = α + β₁LQm + β₂RA + β₃ES + β₄SL + β₅SR + ε

Where

Ym is the CDS spread of French bank m;

LQ is the bid-ask spread of French bank m;

RA is the implied volatility index of CAC 40;

ES is the Euribor spread;

SL is the slope of the yield curve;

SR is the SBF 250 index return.

18. Table 1 shows the baseline quantile regression results averaged across four French banks. The quantile is set to be 95th quantile, a common stress level by risk management standards. All standard errors are bootstrapped so that the estimates are robust even under circumstances that residuals and explanatory variables are not independent. As can be seen from Table 1, all coefficients have the expected signs and are statistically significant.

Table 1.

Baseline Quantile Regression Results

Sources: Fund staff estimates.

In the next step, the baseline regression is augmented with each non-French bank to control for all the above variables.

Ym = α + β₁LQm + β₂RA + β₃ES + β₄SL + β₅SR + β₆CDSn + ε

Where

CDSn is the CDS spread of non-French bank n.

Using coefficients from the 95^th quantile regression, we can get the predicted spreads of each French bank conditional on each foreign bank at the 95^th quantile (a total of 164 predictions). The percentage difference between the predicted and actual spreads at the 95^th quantile indicates the risk dependence among banks.

19. Figure 11 shows the distribution of estimated conditional risk. In particular, after controlling for all the other variables, the direct and/or indirect linkages could lead to an average increase in CDS spreads of 56 percent under extreme stress. The slightly right skewedness indicates that the median increase is somewhat higher. The distribution is in a double-hump shape, implying different repricing of risk depending on the strength of direct and/or indirect linkages of French banks with other large and complex financial institutions.

20. Figure 12 shows the estimated conditional risk depending on the countries under stress. As expected, banks in different countries may have different impact on risks of French banks under extreme stress. U.S. banks have the largest impact while Danish banks have the smallest impact. The impact could be considerable in some cases, but is likely to be manageable since French banks have withstood the subprime induced global financial crisis comparatively well and thus appear to have the relatively moderate risk to begin with.

21. The results from quantifying risk from Greece, Ireland, Italy, Portugal, and Spain (EA5) are largely consistent with those from a detailed analysis of the French banks’ direct exposure to the EA5. Based on the latest BIS data, French bank exposures account for about 7 percent of bank assets and 30 percent of nominal GDP. Of the French exposures to EA5 countries, 15 percent are to Greece, Ireland, and Portugal while 60 percent are to Italy and 25 percent to Spain. Exposures of French banks to EA5 countries are dominated by claims on nonfinancial corporates. The sector breakdown shows that about half of the exposures are accounted for by claims on corporates and a third are accounted for by holdings of government securities (Figure 13). The two French banks most exposed to Greece gain substantial exposures mostly through the loan books in their Greek subsidiaries, which are small in comparison with the size of the respective French parent banks. Individual French banks’ exposures to Greece, Portugal, and Spain range from 2 to 10 percent of equity, compared with about 70 percent of large European banks having exposures above 10 percent of equity and the largest one having exposures of over several times of equity.

D. Conclusions

22. Some tentative findings emerge from the analysis of recent credit dynamics in France and systemic linkages of major French banks with 41 large and complex financial institutions in 16 advanced countries. Evidence from the bank lending survey, the substitution between loan and bond markets, and the SMEs’ access to finance suggests that the still low credit growth is more likely to be demand-driven. The CDS spreads of French banks under extreme stress based on quantile regressions show that their systemic linkages with large and complex financial institutions in other countries could lead to a pronounced increase, on average, in their riskiness. The wide distribution seems to indicate that depending on the strength of the linkages and sources of stress, it is about equally likely to have small and large changes of risks. In case of the large changes of risks, a negative impact on credit may take place, which would call for enhanced vigilance and proactive policies.

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Prepared by Yingbin Xiao.

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