This note estimates potential output for France during 1980–2010, using three distinct approaches, and discusses long-term growth prospects. The focus on capital taxation highlights the need for a broader reform of the French tax system to address the features that hamper job growth, investment, and productivity growth. This paper analyzes the impact of Basel III capital requirements on French banks and the French economy, and proposes policy recommendations. French banks should be able to meet the new requirements through earnings retention.


This note estimates potential output for France during 1980–2010, using three distinct approaches, and discusses long-term growth prospects. The focus on capital taxation highlights the need for a broader reform of the French tax system to address the features that hamper job growth, investment, and productivity growth. This paper analyzes the impact of Basel III capital requirements on French banks and the French economy, and proposes policy recommendations. French banks should be able to meet the new requirements through earnings retention.

III. The Macrofinancial Impact of Basel III Capital Requirements1

This paper analyzes the impact of Basel III capital requirements on French banks and the French economy and proposes policy recommendations. The main results are that, under conservative assumptions, French banks should be able to meet the new requirements by early 2013/14 through earnings retention. The economic costs of meeting the new requirements appear to be manageable. Given the additional potential risks to the economy from systemically important banks, the authorities should encourage banks to improve their capital adequacy promptly to accommodate additional requirements that go beyond Basel III, including the capital surcharge for global systemically important banks (G-SIBs).

A. Introduction

1. The global financial crisis has put to the fore a number of shortcomings in financial system frameworks. In particular, a key lesson of the financial crisis is that banks’ capital adequacy was overestimated as regulation and supervision did not pay enough attention to the quality of capital. Similarly, the risk weights of various instruments held on the trading books of banks and risk weighted assets were underestimated. In addition, the global financial crisis has also highlighted the interconnectedness of balance sheets across sectors and countries. Liquidity risks, both the funding risks incurred by institutions and the associated market liquidity risks of assets, were also much higher than recognized during the crisis.

2. To reduce the likelihood and severity of financial crises, a consensus has been reached at the multilateral level to increase banks’ minimum capital and liquidity standards. The Basel III capital rules, published in December 2010, increase both the quantity and quality of capital. Basel III also introduces two new global standards for liquidity—the liquidity coverage ratio (LCR) and the net stable funding ratios (NSFR)—which are currently under an observation period so as to address unintended consequences. The Financial Stability Board (FSB) is considering a number of measures to address the risks from global systemically important financial institutions, including banks (G-SIFIs and G-SIBs).

3. The ultimate goal of the reform process is to have a safer global financial system that remains sufficiently dynamic and innovative to finance strong and sustained economic growth. The design and implementation of financial regulation should avoid unintended consequences on the real economy. Indeed, regulation involves trade-offs between societal benefits and the private interests of shareholders. As a result, adequate regulation should restore the soundness of the financial sector and reduce the cost to taxpayers as financial crises become less frequent and severe. At the same time, there is a risk that excessive regulation reduces financial intermediation and the flow of credit to the economy with negative real effects. Worse, excessive capital requirements could lead to perverse incentives in the form of higher risk-taking by banks resulting for instance from capital and balance sheet optimization.

4. Ongoing international regulatory reforms will have an effect on French banks and the French economy. French banks will have to comply with the new capital requirements directive (CRD) which will translate Basel III for EU member countries and the largest French banks are likely to be defined as G-SIBs. Within the EU, amendments to the CRD will aim at reflecting the new Basel III capital standards. The CRD, which came into force on 1 January 2007, introduced a supervisory framework within the EU, in part to reflect the Basel II capital rules. The CRD IV modifications, if adopted, would require banks in France and the rest of the EU to secure additional capital to meet the Basel III requirements. Furthermore, given their size and scope, the largest French banks are likely to be defined as G-SIBs and as a consequence will have to meet a capital threshold higher than for Basel III.

5. Against this background, the question at stake in this paper is the likely impact of the proposed regulatory reforms on French banks and the French economy. The paper narrows down its analysis on the Basel III capital requirements as it is the area where the most progress has been achieved in terms of calibration. First, the paper discusses the likely path for French banks to meet the new capital requirements. Second, the paper assesses the cost of higher capital rules to the French economy which can result from higher lending spreads or lower lending volumes. Finally, the paper discusses a number of policy options in light of additional capital requirements beyond Basel III such as the G-SIB surcharge which the largest French banks may need to achieve.

B. Potential Impact of Basel III on French Banks

The Basel III Capital Framework

6. The Basel Committee published new rules on capital in December 2010 which presents a substantial improvement in the quality and quantity of capital in comparison with the pre-crisis situation2. The new global standards (Basel III) raise the level of the minimum capital requirements; introduce a simple capital/asset ratio (leverage ratio); increase risk coverage (in particular for trading activities–already in place since January 2011–and counterparty credit exposures arising from derivatives); and introduce measures to promote the build-up of capital buffers in good times that can be drawn down in periods of stress (a capital conservation buffer). The definition of capital has also been significantly strengthened. The new regulatory definition limits the inclusion of the equity benefit from deferred tax assets, mortgage servicing rights, and minority interests in subsidiaries.

Pre- and Post- Basel III Minimal Global Capital Requirements

(in percent of risk-weighted assets)

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Source: BCBS Press Release, September 2010.

7. The new measures have different implementation schedules. Some have been introduced for observation and monitoring as early as 2011 (such as the leverage ratio), others will have a very gradual implementation until 2023 (phasing out of ineligible capital instruments). In the transition period, supervisors will need to have operational independence, sufficient resources and mandate for more intensive and intrusive supervision.

How Do French Banks Compare to EU Peers?

8. French banks have increased their capital since the financial crisis but are somewhat lagging behind their peers. Comparable banks in a number of EU countries have been recently issuing capital in part due to strong market and supervisory pressures in crisis hit countries as well as uncertain economic prospects. Although, French banks have issued capital in the aftermath of the crisis, they have chosen a more gradual approach and rely more on expected retained earnings to meet the new capital requirements. As a result, French banks at present have a lower capital ratio than many of their peers.


EU Bank Core Tier 1 Ratios, 2010 /1

(Percent of risk-weighted assets)

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A003

Sources: SNL Financial; and IMF staff estimates.1/ Core Tier 1 definition may differ across banks.

9. French banks’ relatively lower capital position is in part due to their higher resilience during the financial crisis. French banks did not receive as much direct public support, in the form of capital injection or preferred shares, than in other countries during the financial crisis as their universal banking model proved to be resilient. As a result, their capital does not benefit from the transitional arrangements which allow public sector capital injections to be grandfathered in the calculation of Basel III capital ratios until January 1, 2018, and preferred shares to be eligible for Tier 1 capital until 2022.

C. How Much Additional Capital Will French Banks Need?


10. French banks’ Basel III capital ratio can be estimated by applying the new capital proposals to their current capital and risk-weighted assets (RWAs) under the current regulatory framework. This approach has been used in quantitative impact studies (QIS) coordinated by the BCBS. In particular, the QIS consider (i) changes to the definition of capital that result in the Basel III common equity core Tier 1 (CET1); (ii) a reallocation of deductions on CET1; (iii) changes to the eligibility criteria for Tier 1 and total capital; and (iv) increases in risk-weighted assets (RWAs) resulting from changes to the definition of capital, securitization, trading book, and counterparty credit risk requirements; and (v) a capital conservation buffer above the CET1 minimum.3

11. This approach considers the full impact of Basel III rules and the resulting capital position of French banks can be seen as an upper bound. The exercise does not take into account most phase-in arrangements and assumes full implementation of the Basel III requirements. The assessment does not make assumptions about banks’ profitability or behavioral responses such as changes in bank capital or balance sheet composition.


Moving to Basel III Capital Ratio

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A003

(1) The excess capital above the minimum of a subsidiary will be deducted in proportion to the minority interest share.(2) Mainly, investments in own shares, other investments in financial institutions, shortfall of provisions to expected losses, cash flow hedge reserves, cumulative changes in own credit risk, and pension fund assets.


12. The sample of the QIS conducted by the French Prudential Supervision Authority (ACP) comprises 11 French banks and includes the four largest institutions. Banks were divided into two groups. Group 1 banks comprised of four banks that are well diversified, internationally active, with Tier 1 capital in excess of €3 billion while the remaining banks were included in Group 2 banks. End-2009 data were made available, on a confidential basis, by banks and reviewed by the supervisory authorities.

13. Results indicate that the CET1 ratio of large French banks would fall below the 7 percent Basel III target. Following the full implementation of Basel III capital requirements, the average CET1 ratio of French Group 1 banks would fall by 45 percent to reach 4.7 percent. This is in contrast to the 7 percent threshold of a 4.5 percent CET1 capital ratio plus a capital conversation buffer of 2.5 percent. In contrast, the CET1 ratio of French Group 2 banks would be higher than the target at 9.4 percent.

14. French banks would therefore need to increase their CET1 ratio in order to meet the Basel III targets. The capital shortfall necessary to meet the 7 percent target reaches €50 billion for Group 1 banks while Group 2 banks do not need to improve their capital to meet the minimum standard. Although this shortfall is about five times (4.6) larger than the net income attributable to shareholders in 2009, it is about twice French banks’ average net income in 2007–09 and 2.6 times 2010 profits.

15. The results are mainly driven by new Basel III rules on capital deductions of holdings in other financial institutions and deferred tax assets (DTAs). CET1 capital would decrease by about 28.9 percent due to the impact of deductions of holdings in other financial institutions. The French universal banking business model leads to such deductions as banks have large shareholdings in insurance companies. Deductions of deferred tax assets affect banks which made heavy losses in the past, or acquired loss making banks. Also, banks with high credit losses tend to have high DTAs. New measures regarding counterparty risk and securitization are the main drivers of the reduction in capital. Indeed, the new rules will require more capital for banks with sizeable market activities and with higher counterparty risk. The impact on RWAs is also important as they would increase by 30 percent as a consequence of higher weights, including for counterparty risk and securitization.

How Do French Banks Compare to EU and Global Banks?

16. The impact of Basel III capital standards on French banks is relatively lower than for EU and global banks. The above results are directly comparable to those from CEBS (2010) (48 EU Group 1 banks from 21 jurisdictions) and BCBS (2010a) (91 global Group 1 banks from 23 jurisdictions), which indicate that the average CET1 of Group 1 banks would fall to 4.9 percent and 5.7 percent, for EU and global banks, respectively. While the French CET1 capital ratio falls by about 45.3 percent following the full application of Basel III, it decreases by 54.2 percent and 48.6 percent of EU and global banks, respectively. As a result, EU Group 1 banks would need to raise €263 or 3.1 times their income attributable to shareholders in 2009. Similarly, global Group 1 banks would have a capital shortfall of €577 billion to meet the new requirements or 2.8 times the level of income to shareholders. For both regions, Group 2 banks would not need to raise much additional capital.

17. Unlike for other jurisdictions, deductions for intangibles are already required under French regulation which mitigates the impact of capital deductions. Although the main drivers of the fall in capital adequacy for all regions are mostly attributable to new capital deductions and filters, French regulation already incorporates the deduction of goodwill which reduces the impact of comparable Basel III standards. On the asset side, French and EU banks will experience an increase in risk-weighted assets from broadly the same sources (charges against counterparty credit risk and securitization exposures in their banking books). At the global level, trading book exposures also increase banks’ RWAs.

Impact of Basel III Capital Standards: France, EU, and Global Banks

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Sources: BCBS; CEBS; Banque de France; Banks financial statements; and staff estimates.

18. The structure of cooperative and mutual banking groups—which are relatively important in France—complicates the transition to Basel III capital rules. French cooperative and mutual banks have complex group structures typically including one joint-stock listed entity and numerous non-listed regional banks, with intra-group equity investments. Capital requirements under this business model are sensitive to changes in the definition of capital and deductions from equity capital envisaged under Basel III. For instance, some instruments such as shareholders’ advances and deeply subordinated notes, are no longer included in the calculation of CET1 under Basel III. Among the solutions considered, the French Prudential Supervision Authority (ACP), which supervises cooperative and mutual banks on a group basis, approved the principle of an intra-group transaction called “switch guarantees” which allowed the listed entity to improve its capital position by repaying deeply subordinated loans and securities to its regional banks in exchange of a security deposit. A similar mechanism will be set up for the insurance subsidiary. This solution enables the listed entity to meet Basel III requirements without requiring a capital increase. In addition, cooperative and mutual banks have added the value of their equity stakes in their parent companies to their RWAs instead of deducting capital which leads to a lower capital increase.

19. French banks that are part of bancassurance groups could benefit from changes in the treatment of insurance deductions in EU regulation. Under the bancassurance model, French banks are large shareholders of insurance companies which account for 10 to 20 percent of total group assets. As discussed earlier, the deduction of holdings in other financial institutions under Basel III is one of the main drivers of French banks’ capital shortfall. However, the impact of insurance deductions could be mitigated by the amendment of the European Financial Conglomerates Directive (EFCD, European Directive 2002/87/EC, scheduled for the second half of 2011) which would require supervisors and groups to measure the prudential soundness of groups with significant business in both the banking/investment and the insurance sectors

D. Can French Banks Meet the Basel III Capital Requirements in time?

20. The profitability of French banks bodes well for their ability to meet the Basel III targets ahead of time. Large French banks have remained profitable during the financial crisis and have been able to almost double their net income attributable to shareholders in 2010. Thanks to this strengthened profitability, the capital shortfall to meet the 7 percent CET1 plus capital conservation buffer now corresponds to about 2.6 times net income (or twice the 2007–09 average net income). As a result, French banks should be able to accumulate enough retained earnings to meet the new capital standards well ahead for the January 2019 Basel III deadline.

21. Assuming a modest earnings growth, French banks should be able to meet the CET1 target by 2013/14 through earnings retention. Starting with actual 2010 profits and dividend payout ratios and assuming an earnings growth rate similar to the consensus estimate for 2010–13, it is possible to estimate French banks’ expected earnings. The resulting average compound annual growth rate (CAGR) of 18 percent would enable French banks to accumulate enough capital to meet the €50 billion capital shortfall (€36.5 billion when 2010 results are taken into account) by early 2013/14, assuming a constant dividend policy. This result is consistent with a study by Otker-Robe and Pazarbasioglu (2010) which finds that most European banks would be able to meet the Basel III capital requirements through earnings retention, provided a modest earnings outlook.

French Banks’ Retained Earnings Forecasts and Basel III Capital Shortfall

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Sources: Banque de France; banks’ financial statements; market consensus; and staff estimates.

22. All major French banks have indicated that they will be able to fully meet the new capital requirements in 2013/14. Such forecasts are also consistent with bank analysts’ simulations, although they are at times difficult to compare given differences in methodology, definition, and forecast horizons.

French Banks: CT1 Targets

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Sources: Banks’ financial statements and presentations.

Net income attributable to equity holders (Eur millions).

Basel III Core Equity Tier 1 capital target, except for BPCE (Basel II definition).

E. The Macroeconomic Impact of Basel III Capital Standards

23. The above analysis suggests that French banks should be able to meet the new capital requirements through retained earnings. It is, however, useful to consider alternative scenarios should earnings forecasts not materialize. The following section estimates the increase in lending spreads and volumes needed to meet the Basel III capital requirements and the associated impact on GDP.

What Will Be the Impact of Basel III Capital Requirements on Lending Spreads and Volumes?

24. A simple accounting-based approach can be used to estimate the impact of capital requirements on lending spreads.4 Consider a stylized French bank with total assets equal to risk-weighted assets consisting in non-remunerated liquid assets and loans. The ratio of liquid assets to total assets is assumed to stand at 22.7 percent using Banque de France data on the French aggregate banking sector. The bank’s liabilities consist in non-remunerated deposits and debt for which the bank must pay 3.5 percent interest rate, which is comparable to French banks’ debt yield from Bloomberg LP. The return on equity is assumed to be 13.4 percent which is the pre-crisis average for 2003–07.

Stylized French Bank Balance Sheet

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25. Under these assumptions, French banks would need to raise their lending spreads by about 30 basis points to meet their Basel III capital shortfall. The stylized bank’s weighted average cost of capital (WACC) is the weighted average cost of debt and capital, which can be rewritten as:


where CAR is the capital ratio and RD = 3.5% and RE = 13.4% are the cost of debt and return on equity (ROE), respectively. A one percentage point increase in the capital ratio would raise the cost of funds (WACC) by about 9.9 basis points. Given this increase in its cost of funds, the bank may increase its return on assets in order to maintain its return on equity. Since liquid assets are non-remunerated, it will need to raise lending spreads. Should the bank choose to do so, the resulting increase in lending spreads to accommodate a one percentage point increase in the capital ratio will be equivalent to 12.8 basis points (as the loan-to-asset ratio is 77.3 percent). Assuming a linear relationship, the spread increase needed to reach the 2.3 percent shortfall in capital ratio would be 29.4 basis points.

26. This result is comparable to those obtained using a broader range of model for a large sample of countries. Using a number of econometrics- and accounting-based models for different countries, BCBS (2010b) finds that the median estimated decline in lending spreads in response to a 1 percentage point increase in the target capital ratio implemented over four years is about 15 basis points percent after 18 quarters relative to the baseline scenario and 16 basis points after 32 quarters.

27. The reduction in the lending volumes of French banks resulting from the new capital requirements can also be estimated. Using balance sheet data from French banks (and excluding a recently created bank for which capital ratio data under all definitions of capital were not available), we estimate the adjustments to their capital and assets in response to differences between their actual and target capital ratios as in the simulation methodology proposed by Francis and Osborne (2009) and BCBS (2010b).5

28. Simulation results indicate a gradual decrease in loan volumes of about 10 percent. Figure below shows the adjustment paths of loan volumes and other variables should banks adjust their capital ratios to comply with the new Basel III capital targets. These results are comparable to BCBS (2010b) which finds, for a broad sample of models and countries, that the worst decline in loan volumes for a 1 percentage point increase in capital requirements would be about 3.6 percent over both two and four years. This would correspond for France to a reduction of 8.3 percent in lending volumes for France as the adjustment in capital for French banks is estimated to be 2.3 percentage points.


Adjustment Paths to Basel III

Citation: IMF Staff Country Reports 2011, 212; 10.5089/9781462338528.002.A003

29. French banks can mitigate the impact on lending volumes and spreads through a combination of measures. Should earnings forecasts not materialize fully, French banks could increase operational efficiency by reducing costs and increasing non-interest fee income. On the assets side, French banks can reduce non-loan assets and shift balance composition towards less risky assets. French banks have also the option to issue new equity as many peer European banks have already done. Such choices will depend on banks’ management decisions regarding changes in their business models and the likely impact on profitability and shareholders’ return on equity. French banks are reluctant to raise capital (for those that are publicly listed) because of the expected negative impact on shareholders through dilution in a context of lower post crisis return on equity (ROE). Indeed, many bank analysts expect ROEs not to exceed 10 percent in the post crisis environment.

What Will Be the Impact of Basel III Capital Requirements on GDP?

30. The impact on GDP resulting from the new regulatory changes can be assessed by using the above changes on lending spreads and volumes as inputs in macroeconomic models. BCBS (2010b), for instance, uses standard semi-structural and DSGE models, including bank-augmented DSGE models from central banks to estimate the likely fall in GDP from higher lending spreads or lower lending volumes. The main transmission channels are a possible reduction in spending by households and businesses with negative effects on consumption and investment expenditure; a shift in the credit supply towards capital markets and non-bank financing; and possible spillover effects from other countries if regulatory changes are applied by all countries at the same time.

31. The resulting fall in the level of GDP would be around 30 basis points if French banks increase their lending spreads to meet the new 7 percent Basel III target. Using different macroeconomic models for a broad sample of countries, BCBS (2010b) finds that the size of a fall in the level of GDP following an increase in the capital adequacy ratio is comparable to the increase in lending spreads, which for the case of France would then be about 30 basis points as estimated in the previous section6. This figure is comparable to estimates from Banque de France which indicates that higher lending spreads as a result of Basel III implementation would lead to a fall in the level of GDP of about 30 basis points by 2018.

32. The impact of regulatory changes on the French economy can, however, be mitigated by a number of factors. Large corporate which have access to capital markets funding may rely less on bank funding or increase their retained earnings to accommodate an increase in the cost of funds borrowed from banks (the average corporate debt-to-equity ratio stood at about 31.6 percent in 2010). However, SMEs would not be able to substitute bank loans with other types of financing unless they increase their retained earnings. Monetary policy can also be expected to react to weaker growth and reduced inflation.

F. What Are the Capital Requirements Beyond Basel III?

33. Basel III also proposes an additional capital increase in the form of a countercyclical buffer. In addition to the Basel III CET1 ratio plus conservation buffer discussed above, current regulatory reforms propose that banks build a countercyclical buffer which could be as high as 2.5 percent of RWAs. However, implementation of this countercyclical buffer will be according to national circumstances. The countercyclical capital buffer aims at protecting the banking sector from periods of excess aggregate credit growth, which has often been a key determinant of increased systemic risk. Furthermore, it is important to note that the Pillar II approach which pre-dates Basel III gives supervisory authorities a discretionary prerogative to require additional capital from banks or higher risk weights.

34. Regulatory reform is also progressing to go beyond the Basel III standards to address the risks stemming from global systemically important financial institutions (G-SIFIs). A workable set of criteria to identify G-SIFIs, including banks (G-SIBs) and how much systemic risk they embody is currently being developed. A number of tools have been considered to address the systemic risks that they collectively generate both in terms of solvency and liquidity. “Price-based” tools seek to give these institutions incentives, for instance through a combination of capital or liquidity surcharges, contingent capital instruments or levies, to avoid contributing to these risks. Alternatively, “quantity-based” tools attempt to limit or remove positions or business activities deemed to contribute to systemic risk, such as those under the so-called “Volcker rule,” which bans proprietary trading, private equity, and hedge funds within a U.S. commercial bank. Although these potential tools are still under construction, a guiding principle is to apply them in such a way that those institutions that contribute most to systemic risks also carry the largest burden.

35. The regulatory agenda goes beyond capital rules to encompass supervision and other tools that should strengthen financial stability. For instance, the financial stability board (FSB) agenda regarding G-SIFIs is relatively comprehensive and includes not only requirements for additional loss absorption capacity for SIFIs but also other measures. Higher loss absorption capacity could include a combination of a capital surcharge, a quantitative requirement for contingent capital instruments and a share of debt instruments or other liabilities represented by claims which would bail-in the private sector. Other measures include improvements to resolution regimes; more intensive supervisory oversight; more robust standards for core financial infrastructure to reduce contagion risks from the failure of individual institutions; and review by an FSB Peer Review Council of the effectiveness and consistency of national policy measures for G-SIFIs. Avoiding regulatory arbitrage should also a key objective of regulatory reform.

36. A global systemically important banks (G-SIB) capital surcharge would probably affect all the four largest French banks. The FSB is discussing modalities to identify G-SIBs and the size of an additional capital buffer is not yet finalized. Nonetheless, an impact on the French bank system should be expected as it includes some of the largest banks in the world. Measures would include (i) a methodology for assessing systemic importance based on size, interconnectedness, lack of substitutability, global (cross-jurisdictional) activity and complexity, (ii) additional Common Equity Tier 1 (CET1) capital requirement ranging from 1 percent to 2.5 percent, depending on a bank’s systemic importance and an additional 1 percent surcharge to provide a disincentive for banks facing the highest charge to increase materially their global systemic importance in the future; and (iii) phase-in arrangements in parallel with the Basel III capital conservation and countercyclical buffers between 1 January 2016 and year end 2018.

Basel III and Current Capital Proposals

(in percent of risk-weighted assets)

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Source: BCBS, Press Release, September 2010.

Not mandatory; to be implemented according to national circumstances.

Capital surcharge for Global Systemically Important Banks (G-SIBs) under consideration.

37. Assuming a hypothetical additional G-SIB surcharge of 2.3 percent, French banks appear likely to meet their capital shortfall by early 2015 through retained earnings. In order to have an idea of the likely impact of a G-SIB surcharge on the French banking system, we assume that banks are require to make an effort similar to the one needed to meet the Basel III CET1 ratio and the supervisor does not require a countercyclical buffer given the current economic recovery. Under the same retained earnings forecasts and payout policy as before, French banks could meet the capital shortfall by 2015. Assuming a linear relationship, the impact of a hypothetical 2.3 percent capital surcharge on the level of GDP would be twice the size of the previous results or 60 basis points. This result can be seen as an upper bound as the G-SIB surcharge for some French banks will likely be lower.

Franch Banks: Retained Earnings Forecasts and Hypothetical G-SIB Capital Shortfall

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Sources: Banque de France, Banks’ Financial Statements, Market consensus and Staff estimates.

38. The above conclusions are, however, sensitive to French banks earnings forecasts and ignore downside risks. Notwithstanding the materialization of a tail event, a number of risks to the French banking system can be identified. Indeed, French banks remain dependent on wholesale funding, including from U.S. money market funds even though they have been able to refinance and fund themselves at relatively low cost. Unsettled EU sovereign debt markets, rising housing prices in France coupled with a faster growth in mortgage lending and the tightening of monetary policy all combine to make banks’ operating environment challenging.

G. Policy Conclusions

39. Increasing capital would strengthen the resilience of the French financial sector. Although France has weathered the financial crisis better than many other countries, future tail global events cannot be discounted and a number of risks make the operating environment fragile. In addition, the associated welfare benefits of reducing the frequency and severity of a future financial crisis, especially in light of the limited fiscal space, should be weighed against the economic costs of higher capital requirements. Finally, a stronger capital position will help meet the Basel III liquidity requirements (NSFR), by increasing the numerator of the target ratio (available stable funding).

40. The associated costs to the French economy of increasing banks’ capital appear to be manageable. A challenging policy question is how best to strengthen the French financial system and at the same time ensure that it continues to adequately finance the economy. The results above as well as from BCBS (2010b and 2010c) suggest that macroeconomic costs should be manageable for French banks.

41. The authorities should encourage French banks to rapidly meet the Basel III capital requirements ahead of the January 2019 deadline. Although the Basel III implementation period gives French banks time for implementing the new measures, French banks should be encouraged to meet the CET1 target capital ratio expeditiously. Under conservative earnings forecasts, French banks should be able to meet the capital targets by 2013/14 through earnings retention. Although this timeframe is well before the end of the phase-in period, it is nevertheless sufficiently long to avoid excessively negative impact on lending. The supervisor should continue to ensure that banks implement their announced capital augmentation programs including through restrictions on dividend distribution and stock repurchase. To signal commitment, consideration could be given to making such programs a formal requirement. Although possible under the Pillar 2 approach, a mandatory but reachable path for capital increase would be an affordable way to gain credibility and publicly showcase the solidity of banks and the determination of the French supervisor.

42. Meeting Basel III capital rules expeditiously will put French banks in a strong footing to implement forthcoming additional capital requirements for G-SIBs. Given their global and systemic nature, the largest French banks are likely to be defined as G-SIBs whose capital requirements will exceed Basel III rules. Without prejudging the conclusions of the ongoing FSB discussions on G-SIBs, the largest French banks are likely to be required to increase their capital further to improve their loss absorption capacity. The economic impact of capital requirements beyond Basel III will need to be further studied and the BCBS is considering a cross-country study with a focus on G-SIBs.


  • Barrell, R., E. Davis, T. Fic, D. Holland, S. Kirby, and I. Liadze, 2009, “Optimal Regulation of Bank Capital and Liquidity: How to Calibrate New International Standards,” U.K. Financial Services Authority, Occasional Paper Series, No. 38.

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  • Basel Committee on Banking Supervision (BCBS), 2010a, “Results of the Comprehensive Quantitative Impact Study” (December).

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Prepared by Amadou Sy. The author wishes to thank staff from Banque de France and ACP as well as Matthew Osborne (U.K. FSA).


For more details, see BCBS (2010a), CEBS (2010), and Okter-Robe, Inci, and C. Pazarbasioglu, (2010). One should note, however, that RWAs across different countries are not yet harmonized.


An econometric approach, as in Barrell et al. (2009) can also be used to estimate the impact of capital requirements on lending spreads. BCBS (2010b) notes, however, that the accounting-based approach forecasts spread increases that are broadly similar to those from the regression approach.


The model is calibrated using adjustments factors for U.K. banks from Francis and Osborne (2009). The model simulates the impact of a change in capital requirements on banks’ balance sheet and capital elements. It assumes that banks manage their capital to meet a desired, or long run, target that depends significantly on capital requirements. In order to meet higher targets, banks are assumed to reduce assets by increasing lending rates or selling assets and increase capital by raising new capital or retaining earnings. The growth rate in asset and capital is regressed on bank-specific and macroeconomic variables.


BCBS (2010b) finds that a one percentage point increase in the target CET1ratio lead to a decline in the level of GDP no higher than 19 basis points after four and half years. This is equivalent to a reduction in annual GDP growth of 0.04 percentage points.