France
Financial System Stability Assessment

This Financial System Stability Assessment paper on France provides summary of an assessment of the financial system. Dominated by internationally active financial conglomerates, the French financial system has made important progress since the last financial stability assessment program (FSAP). In order to address a build-up of systemic risks, the authorities have proactively used macroprudential measures and public communication. The government is pursuing a strategy to prepare Paris as a key financial hub, including by promoting crypto-assets, fintech, green finance, and market entry. Banking and insurance business lines, and the corporate sector, carry important financial vulnerabilities that need close attention. The FSAP thus has recommended augmenting policy tools to contain vulnerabilities and continue to act pre-emptively if systemic risks intensify. In order to mitigate intensification of corporate—and potentially household—vulnerabilities, the FSAP proposed: active engagement with the European Central Bank on the possible use of bank-specific measures; considering fiscal measures to incentivize corporates to finance through equity rather than debt; and a sectoral systemic risk buffer.

Abstract

This Financial System Stability Assessment paper on France provides summary of an assessment of the financial system. Dominated by internationally active financial conglomerates, the French financial system has made important progress since the last financial stability assessment program (FSAP). In order to address a build-up of systemic risks, the authorities have proactively used macroprudential measures and public communication. The government is pursuing a strategy to prepare Paris as a key financial hub, including by promoting crypto-assets, fintech, green finance, and market entry. Banking and insurance business lines, and the corporate sector, carry important financial vulnerabilities that need close attention. The FSAP thus has recommended augmenting policy tools to contain vulnerabilities and continue to act pre-emptively if systemic risks intensify. In order to mitigate intensification of corporate—and potentially household—vulnerabilities, the FSAP proposed: active engagement with the European Central Bank on the possible use of bank-specific measures; considering fiscal measures to incentivize corporates to finance through equity rather than debt; and a sectoral systemic risk buffer.

Executive Summary

Important institutional and policy changes have taken place since the 2012 FSAP. At the national level, the authorities have strengthened the macroprudential framework by establishing the High Council for Financial Stability (HCSF), enhanced monitoring of financial stability risks, prepared to manage the Brexit fall-out, introduced macroprudential measures, and taken various financial reform measures included in Loi PACTE—Action Plan for Business Growth and Transformation—and initiatives on digital finance, crypto-assets, green finance, and combating cyber risk. At the European level, significant changes include the Banking Union (BU), Capital Requirements Regulation/Capital Requirements Directive (CRR/CRD), Solvency II, and efforts towards a Capital Markets Union (CMU).

The financial system is more resilient than it was in 2012. Capital positions and asset quality have improved. Banking business is better placed to handle cross-border contagion, including from exposures to high-yield EA economies. Insurers’ solvency ratios have been stable and have been bolstered by the effective implementation of Solvency II. Household savings and balance sheets are relatively sound and house prices presently appear broadly aligned with fundamentals.

But there are several challenges. Private nonfinancial sector and public debt has continued to rise. Consolidated corporate debt is, on average, not higher than in many peer countries, but there is some concentration of vulnerable corporate debt. Bank credit to nonfinancial firms and households has expanded relatively fast. Profitability is subdued, and margins remain under pressure due to the interest rate environment, lower revenue from market-related business, and stronger market competition. The reliance of banks on wholesale funding is better managed but is still sizable. Nonbanks—insurers and investment funds—are playing a larger role given the growing cross-border and non-EU exposures. Finally, the incomplete BU and the slow progress towards CMU are creating uncertainty and constraining faster shifts in business models.

Banking and insurance business lines, and the corporate sector, carry important financial vulnerabilities that need close attention. Banks have adequate capital and liquidity buffers to withstand a sizable shock, though an increase in wholesale funding costs could pose further risks to profitability and solvency. Similarly, banks could face liquidity challenges from large outflows of wholesale funding, including in U.S. dollars, and from any acceleration of fragmentation of international liquidity. Insurers are broadly resilient against market shocks, but vulnerabilities stem from the concentrated exposures, mostly to their parent banks. Risks from a tail of highly indebted corporates appear manageable, though stress tests show that some banks’ large exposures to highly indebted corporates may increase notably under stress.

The French financial conglomerate (FC) and bancassurance models thus far have worked well, and the authorities’ view is that they have imparted stability. A hallmark of the financial system, the FCs offer a range of services including banking, insurance, and asset management; the diversity of their revenue streams has helped sustain the FCs. But, by its nature, the model is complex to manage and exposed to contagion and unexpected reputational risks. Banks and insurers hold large common exposures through marketable securities creating susceptibility to similar type of market shocks. In the context of continued weak profitability of the banking business, insurers and investment funds are beginning to play a larger role in supporting the performance of their groups, including via well-established risk transfer arrangements, and conglomerate-level prudential optimization. Insurers’ concentrated exposures to their parent banks also indicate vulnerabilities to unexpected large funding withdrawals affecting all business lines within the FC.

The FSAP identified the following key policy priorities (Table 1):

  • Continue pre-emptive management of systemic risks. To address a buildup of systemic risk including private nonfinancial sector debt, the authorities have proactively used macroprudential measures. Looking forward, they should evaluate the effectiveness of these measures, intensify monitoring of risks, and stand ready to act if needed. The authorities should engage with the ECB and other EU agencies on the possible use of bank-specific Pillar II measures to address bank-specific residual risks from the concentration of exposures to large indebted corporates; consider the use of a sectoral systemic risk buffer (SRB); expand the macroprudential toolkit for corporates and nonbanks; and further incentivize financing through equity fiscal measures. Some of these actions will require interagency consultations.

  • Ensuring adequate liquidity management and buffers. While aggregate bank liquidity buffers appear adequate, the supervisory authorities are encouraged to consider imposing additional liquidity buffers in all major currencies to minimize risks related to potential disruptions in wholesale funding in case of severe shocks.

  • Further integration of conglomerate-level monitoring and oversight. To allow the FC model to continue to operate on a safe and secure basis, stronger systemic risk monitoring and cross-sectoral oversight practices of liquidity and solvency conditions are crucial. The rising importance of nonbank financial intermediation requires enhanced supervisory coordination to monitor and limit risks from direct and indirect exposures between entities within the FC. Common guidance, reporting, integrated liquidity risk management requirements, and stress testing at the conglomerate level can help ensure that risks are promptly identified and addressed. Several of the gaps are universal in nature and would benefit from a broader international effort.

  • Enhancing governance, financial sector policies, and financial integrity. In line with international best practices, and critical for achieving their technical mandates in an accountable manner, governance and operational independence reforms are required to ensure that the oversight authorities are properly positioned and resourced to deliver their mandates effectively. The authorities should aggressively pursue the implementation of financial sector reforms as envisaged in Loi PACTE, review the Regulated Savings framework, and enhance financial integrity (AML/CFT framework).

  • Reinforcing crisis management, safety nets, and resolution arrangements. Continued implementation of crisis management instruments created under the EU Bank Recovery and Resolution Directive is essential. Recovery and resolution planning for nonbanks needs attention. The insurer resolution framework has been strengthened, though the assessment against the Financial Stability Board’s Key Attributes suggests that further enhancements are needed, such as powers to mandate the bail-in of liabilities and privately financed resolution funding.

Table 1.

France: 2019 Key FSAP Recommendations

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I= immediate (within one year), NT= near term (1–3 years), MT= medium term (3–5 years).

Macrofinancial Context

A. Macrofinancial Conditions and Trends

1. Growth declined in 2018 but remained relatively resilient (Figure 1 and Table 4). Real GDP growth reached a peak of 2.3 percent in 2017, benefiting from the global environment, while unemployment has started to decline. Since then, real GDP growth has slowed down to 1.7 percent in 2018 and is expected to reach 1.3 percent in 2019, which is still above the EA average. Growth has been primarily supported by private consumption as well as investment.

Figure 1.
Figure 1.

France: Contribution to Annual Real GDP Growth

(Percent; YoY growth)

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Source: INSEE (Haver Analytics) and IMF staff calculations.
Table 2.

France: Interlinkages Among Institutional Sectors in France, 2018: Q2

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Sources: Sectoral Financial Accounts, Banque de France, and IMF staff.

Also includes Non-profit institutions serving households

Table 3.

France: Stress Scenarios for Corporates

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Source: ORBIS and IMF staff estimates
Table 4.

France: Selected Economic and Social Indicators, 2015–24

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Sources: Haver Analytics, INSEE, Banque de France, and IMF Staff calculations.

2. Financial conditions have remained accommodative, and the credit growth is relatively robust (Figures 2 and 12). The credit-to-GDP gap is estimated at 2.7 percent at end-2018 (slightly below the 3.2 percent level in 2017).1 Supported by accommodative monetary policy, bank credit growth has remained broad and dynamic, at around 5 ½ percent in 2018 and in the first four months of 2019 (Figure 2). Low borrowing costs have supported an acceleration of the financial cycle over the last few years, as evidenced by a pickup in bank credit, leverage, financial asset prices, and real estate. Fierce price competition among banks to maintain domestic market shares has compressed margins, especially on housing loans, while their large cash reserves at the ECB deposit facility have earned negative returns.

Figure 2.
Figure 2.

France: Financial Cycle

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: Haver Analytics; Banque de France (BdF); European Central Bank (ECB); EuroStat; and IMF staff calculations based on the Global Financial Stability Report (GFSR) methodology.Note: The credit-to-GDP gap is constructed as the deviation from a moving average of the credit-to-GDP ratio over the previous eight quarters.
Figure 3.
Figure 3.

France: Private Debt

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: Haver Analytics; and IMF staff calculations.Note: Figures are based on national account data, which may not yet incorporate the reclassification on the French National Railways (SNCF) into the general government for the years 2016 and 2017.
Figure 4.
Figure 4.

France: Bancassurance Model of Large French Banks

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Source: BMI Research.
Figure 5.
Figure 5.

France: Financial Performance of French Banks

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: FINREP; SNL financials; and Bloomberg Finance L.P.Note: In panel 1, the dotted lines are weighted averages of analyst forecasts of RoA for each sample bank.
Figure 6.
Figure 6.

France: Insurers’ Fixed-Income Portfolios

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: IMF staff calculations based on ACPR data.Notes: Stress test participants only. Excluding unit-linked and index-linked insurance. High-yield EU countries include Greece, Italy, Spain, and Portugal.
Figure 7.
Figure 7.

France: Real Housing Price Index

(1996Q1 = 100)

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: BdF; INSEE; OECD; SOeS; and IMF staff calculations.
Figure 8.
Figure 8.

France: Holders of Marketable Securities by Counterparty Sector

(Billions of euros)

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: Banque de France; and IMF staff calculations
Figure 9.
Figure 9.

Significant Trends in Cross-Border Common Exposures (Index)

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: Banque de France; and IMF staff calculations.Note: Common exposure indicates the extent to which portfolios overlap. It is a function of the distance between vectors, which in turn is a non-linear function of correlation; this is used in data analysis to group more similar clusters of data together. High common exposure between two entities means that there is a significant portfolio overlap (significant positive correlation between vectors), indicating that entities are susceptible to similar types of shocks.
Figure 10.
Figure 10.

France: Total Large Exposures of Banks to Corporate Debt-at-Risk, ICR < 2

(Percent of CET1 Capital)

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Source: ECB; Worldscope; World Economic Outlook (WEO); and IMF staff estimates.1 SNCF not included; Stress scenario estimates the expected debt at risk. Note: Sample includes five banks.
Figure 11.
Figure 11.

France: House Price Growth-at-Risk One Year Ahead

(5th percentile)

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Source: IMF staff estimates.
Figure 12.
Figure 12.

France: Macrofinancial Conditions

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

3. Private and public leverage is high compared to the EA, leaving balance sheets with reduced space to accommodate shocks (Figure 3).2

  • Nonfinancial corporate borrowing has significantly contributed to the rise in private debt. Unconsolidated nonfinancial corporate debt increased from 110 percent of GDP in 2010 to 141 percent of GDP at end-2017, driven mainly by loans among nonfinancial corporates and bond issuances. Netting out loans among nonfinancial corporates, consolidated corporate debt-to-GDP is lower at 89 percent of GDP and is close to the EA average.

  • Household debt has risen, but from a relatively low base, from 53 percent of GDP in 2010 to 58 percent of GDP in 2017.

  • General government debt rose to almost 100 percent of GDP in 2018 from 83 percent of GDP in 2009.

B. Structure and Performance Financial Conglomerate Structure

4. Within the FCs, there are four global systemically important banks (G-SIBs) and one large global asset manager. There is also a global systemically important insurer and a large global reinsurer. Total financial system assets are about 600 percent of GDP. Combined assets of the four G-SIBs stood at EUR 6.3 trillion as of end-2017 (about 80 percent of total banking assets), or about 270 percent of France’s GDP. The FCs are active in about 80 countries, with important exposures in other EA countries, notably Belgium, Germany, and Italy, as well as in the United States, the United Kingdom, Japan, and several emerging markets (Figure 13). The share of nonbank in total financial assets has risen to 40 percent in 2017 (Figure 14). The insurance sector is one of the largest in the EU with more than 700 firms. Insurers combine life and non-life business, while some groups have significant operations abroad. Investment funds assets reached 60 percent of GDP at end-2018, one of the largest shares among EA countries. The investor base of investment funds is mainly domestic, including insurers (36 percent) and households (18 percent); about half of funds are invested domestically and the rest in the EA, and globally.

Figure 13.
Figure 13.
Figure 13.

France: French Large Financial Groups International Footprint

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: Banks’ financial statements; SNL Financials; IMF Financial Soundness Indicators; Haver Analytics.Note: French large financial groups include the four G-SIBs—BNP Paribas, Credit Agricole, Societe Generale, as well as BPCE. The banking footprint captures the total assets of material foreign subsidiaires in each country. For Japan, South Korea, Taiwan, and India total assets refer to the branch assets. For other countries it is possible for a financial group to have both subsidiary and branch presense, but branch financial disclosure is not available. The insurance footprint refer to the total number of insurance-related entities from these financial groups in each country, including life insurers and reinsurers. The data on total assets are not generally available for these entities.
Figure 14.
Figure 14.

France: Structure of Financial System

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

5. The FCs combine business lines across banking, insurance, and asset management, including through partnerships and subsidiaries (Figures 4 and 15). Successive phases of bank restructuring and consolidations in past decades have resulted in large and diversified FCs. Two of the FCs have large foreign operations, which account for almost 80 percent of their assets, and important investment banking activities, while the other two are more retail-oriented and domestically focused, with core regional businesses. The business model has allowed conglomerates to integrate and optimize products, client services, liquidity management, and income flows across banking, insurance, and asset management companies.

Figure 15.
Figure 15.

France: Business Models of Large French Banks

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

6. Business models are adapting to changing market conditions and digitalization. As response to market conditions and low earnings, two of the four G-SIBs have either already closed their proprietary trading subsidiary or have announced closing it. Several banks have announced reorganizations of retail networks. Newly minted small fintech businesses and nonbanks are impacting the ways domestic retail financial services are offered, with active participations of financial groups, which are also developing green finance products. Banks and insurers are proactively adopting climate risk management practices.3

7. The state plays a consequential role in the intermediation of savings. The nearly 200-year old “regulated savings,” for instance, used largely to finance social projects, are popular due to favorable tax treatment, government guarantees, and fixed returns. A part of this pool of savings, amounting to some 11 percent of GDP at end-2017, is centralized at and managed by the Caisse des Dépôts et Consignations (CDC). Life insurance products also have a built-in savings component. This particularity of savings accounts and products may impact the funding profile of banks, the prudential treatment of such savings, and profitability.4

Performance

8. Despite improving capital and asset quality, profitability remains challenged for French banks (Table 5, Figures 5 and 16). Interest margins have improved since the global financial crisis (GFC) but are still among the lowest in the EA. The lending spreads for the domestic market are especially low, due to low interest rate, fixed rate mortgages, and low margins on corporate lending. In addition, retail funding cost is higher for French banks, likely due to regulated savings scheme and competition from both bank and nonbank institutions. French banks can tap wholesale funding at a relatively low rate due to their strong credit rating, but their high reliance on wholesale funding could leave them vulnerable to changing market conditions, especially for the short-term market. Operational margins are squeezed by the low-cost efficiency. More flexible labor market and further consolidation in the branch networks could reduce the rigidity of the cost structure.

Table 5.

France: Core Financial Soundness Indicators, 2013–18

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Sources: Banque de France, ACPR

These may be grouped in different peer groups based on control, business lines, or group structure.

Consolidated data for the five banking groups (IFRS).

2017–18 based on consolidated data, and thus not comparable with previous years’ unconsolidated data. In particular, the level of consolidation has changed from the establishment level to the FINREP consolidated approach.

All credit institutions’ aggregated data on a parent-company basis.

ROA and ROE ratios are calculated after taxes (same calculation as the ECB consolidated data ratios).

2015–18 data is based on new methodology which is not comparable to older figures.

Figure 16.
Figure 16.

France: Banking Sector Performance

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

9. The earnings outlook is pointing to a continued weakness in profitability. In response to margin pressures, banks have tried to increase their business volumes and fee generating activities. Some banks have aggressively increased their market shares in mortgage markets and/or increased their revenues by expanding the distribution of insurance and asset management products. However, the impact on profitability from the business transformation is likely to take time to materialize. The need to improve IT infrastructure and competition from fintech and nonbanks are additional factors weighing on earnings outlook. The incomplete BU and the slow progress towards CMU are further constraining opportunities for risk taking and balance sheet growth in the EA.

10. French insurer’s solvency ratios have been stable since the introduction of Solvency II (Figures 17 and 18). In recent years, the insurance sector has recorded an aggregate return on equity between 6 and 8 percent. Most French insurers can comfortably meet the Solvency Capital Requirement (SCR) ratio without recourse to transitional measures. Life insurers have expanded further into unit-linked business to reduce capital requirements. The nonlife insurance lines of business have shown a combined ratio below 100 percent in the last five years, indicating that the industry is consistently making an underwriting profit. Insures’ investment holdings are characterized by a high share in fixed-income securities. Half of sovereign bond exposures are domestic, and 70 percent of corporate bonds are being rated A or better (Figure 6).

Figure 17.
Figure 17.

France: Nonbank Sector Overview

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: Banque de France; and IMF staff calculations based on EIOPA.Note: Due to the Solvency II implementation, gross technical provisions of insurers before and after 2016 are not directly comparable.
Figure 18.
Figure 18.

France: Key Nonlife Insurance Metrics and Insurance Company SCR Ratios

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

C. Nonfinancial Firms and Households Balance Sheets

11. Nonfinancial corporations’ debt has been rising in percent of GDP, unlike some other European countries (Figure 19). Bond issuances supported by the low interest rate environment and loans among the nonfinancial corporates (NFC) account for the bulk of the debt increase in recent years, while bank credit has also grown broadly across various sectors and firm sizes, albeit at a slower pace. The debt increase has been accompanied by an increase in cash holdings at the macro level, while low interest rates helped contain debt service ratios.

Figure 19.
Figure 19.

France: Corporate Debt

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

12. At the consolidated level, firm-level debt ratios and interest coverage ratios (ICRs) are broadly in line with peer countries, though a tail of weak firms exists. There has been a moderate decline in debt ratios on average, with an uptick for large firms in recent years. The stock in debt and its recent increase are concentrated in several sectors, as in other countries, while cash buffers have not increased commensurately among firms with weak debt-servicing capacity.

13. Household savings and balance sheets remain relatively sound. Households’ debt has risen since the GFC but is not high in international comparisons (Figure 20). Aggregate households’ balance sheets seem strong as they have accumulated financial assets faster than debt, including through investments in life insurance and saving accounts. However, some households’ balance sheets could be turning weak (see the risk analysis section). French households’ financial savings rate net of the increase in debt is healthy at about 4.5 percent of disposable income, above that of many peer countries. It is necessary though to monitor it closely, in some segments of the population where vulnerabilities may emerge.

Figure 20.
Figure 20.

France: Households Balance Sheet

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

14. House prices presently appear broadly aligned with fundamentals. The recent price inflation seems to largely reflect developments in specific markets, including Paris and a few other cities (Figure 7). The price-to-income ratio of residential real estate has been stable. Furthermore, in recent years, many households have re-negotiated housing loans at low fixed interest rates and are protected from future rises in market interest rates.

D. Interconnectedness

15. Complexities arise from the intertwined and international sub-sectors of the financial system (Table 2). The banking business is global with a third of its claims and liabilities, at around 135 percent of GDP, being cross-border. Insurance liabilities are mostly with households and one-third of their assets are held abroad. Foreign investors hold 50–55 percent of debt securities issued by the sovereign, banks, and NFCs. NFCs have large intra-sectoral linkages and are strongly interconnected with the financial sector and the rest of the world through equity claims, loans, and debt securities. Insurers have the largest exposures to the French government and to domestic NFCs. While banks’ holdings of French government bonds dominate, their exposures to nonbanks have been increasing. Higher holdings of NFC marketable securities by insurers and funds account for the bulk of the increase observed in marketable securities of NFCs since 2011 (Figure 8).

16. The characteristics of cross-border exposures of marketable securities are evolving, with more activities by insurers and investment funds (Figure 2123). Cross-border positions of marketable securities have decreased for banks but gone up for insurers and investment funds. At the same time, common cross-border exposures— which measure the similarity in portfolio compositions—are relatively high (Figure 9). Banks have reduced cross-border positions by 39 percent between 2011 and 2017 and increased domestic holdings. In contrast, insurers and investment funds have increased cross-border exposures by 25 percent and 47 percent, respectively, 2011 to €1.15 trillion and €784 billion between 2011 and 2017.

Figure 21.
Figure 21.

France: Domestic and Cross-Border Exposures in Marketable Securities

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: Banque de France; and IMF staff calculations.
Figure 22.
Figure 22.

France: Domestic and Cross-Border Exposure Composition

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: Banque de France; and IMF staff calculations.
Figure 23.
Figure 23.

France: Network Visualization of Cross-Sector Exposures

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: HCSF; and IMF staff calculations.Note: Only exposures over 1-billion euros are shown. The panel above show bilateral exposures between funds, banks, and insurance companies exceeding EUR 1 billion. Vertices represent individual institutions, while vertex size represents total marketable securities held as assets. In the top panel, edges represent assets, whereas in the bottom panel they represent liabilities. Edges are directed, and they colored according the source of the edge.

Systemic Risk Analysis

A. Key Vulnerabilities

17. The FSAP risk analysis considered the following vulnerabilities: (i) continued pressures on bank earnings and dependence on wholesale funding in major currencies for some international activities; (ii) high leverage and low debt-servicing capacity among a tail of the nonfinancial corporations despite low interest rates; and (iii) significant exposures to EA countries with high debt levels. It examined the resilience of banks, insurers, and corporates from a systemic risk perspective (Appendix III and IV).

B. Key Risks

18. The key risks considered are (Table 6):

  • An abrupt tightening of financial conditions and distress in U.S. dollar funding market arising from shifts in market expectation of tighter U.S. monetary policy;

  • A sustained rise in risk premia for banks and sovereigns from a disorderly Brexit and/or from concerns about debt levels in some EA countries; and

  • A weaker than expected European economic growth from global protectionism and retreat from multilateralism, adverse market reactions to debt burdens and Brexit, and weakening of reform implementation in France.

Table 6.

France: Risk Assessment Matrix

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C. Bank Solvency

19. The simulated adverse stress scenario combines lower growth and tighter financial conditions while ECB monetary policy remains accommodative and policy rates constant (Figure 24).5 Using the Global Macrofinancial Model (GMM), the scenario targets the severity benchmark under the 5 percent probability predicted by the Growth-at-Risk (GaR) model over a three-year horizon. The GDP falls 7.1 percent below baseline by 2021 before gradually rebounding. Inflation and asset prices are expected to undershoot the baseline by 2.3 and 25 percentage points, respectively, and French sovereign risk premia increase by 150 basis points. Corporates and sovereigns in the low- and high-spread EA countries are expected to face higher risk premia of different magnitude, following a decompression of term premia by 120 and 240 basis points, respectively, calibrated on shocks experienced during the GFC and EA crisis. Results are reported for: (i) baseline; (ii) adverse dynamic;6 (iii) adverse static; and (iv) adverse static with funding cost loop projections scenarios.

Figure 24.
Figure 24.

France: Solvency Stress Test Scenario Assumptions

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: EBA; WEO; and IMF staff calculations.Note: Baseline based on February 2019 WEO.

20. Banks have adequate capital buffers, but adverse shocks to wholesale funding costs would deteriorate capital positions. Capital buffers include those provided through Pillar 2 Requirement (P2R) and Pillar 2 Guidance (P2G) imposed by the Single Supervisory Mechanism (SSM). Banks are primarily exposed to risks related to losses from lending to the corporate sector and a rise in wholesale funding costs associated with higher risk premia. Credit risks stemming from housing loans remain contained given: (i) relatively strong aggregate households’ balance sheets; (ii) no evidence of significant misalignment in house prices; (iii) strong social safety nets; (iv) fixed rate housing loans, and (v) interest rate risks on these exposures being hedged. Shocks to wholesale funding costs would have higher impact on banks with higher wholesale dependence and lower earnings.

21. In line with the severity of the shock, capital depletions under adverse scenario are relatively high; however, no bank would face a capital ratio below the minimum 8 percent of Common Equity Tier 1 (CET1) over the five-year horizon (Figure 25).7 In the baseline, the system wide CET1 capital adequacy ratio (CAR) would decline very modestly due to deteriorating macro conditions over the three-year horizon, while in the adverse dynamic scenario, total CET1 capital ratio declines by 270 basis points. In the adverse static scenario and adverse static with funding cost loop tests, CET1 capital ratio would fall by 430 basis points and 540 basis points, respectively.8 Shocks to real estate prices, valuation of Level 3 assets, or loss given defaults (LGDs) on mortgage portfolios do not, individually, lead to an additional significant fall in CET1 capital.

Figure 25.
Figure 25.
Figure 25.

France: Solvency Stress Test Key Results

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Source: IMF staff estimates.

22. Going forward, some of the banks would benefit from increasing the share of stable longer-term funding. Reducing reliance on short-term wholesale funding would increase resilience to funding risks in times of stress.9 Similarly, banks with a high share of domestic retail loans are more resilient to shocks. Results are broadly in line with the EBA stress tests, except that the dynamic version of the stress test shows lower CET1 capital depletion due to loans transitioning back to performing status and counter-cyclical increase in non-interest income. Going forward, it would be important to test risks stemming from intragroup activities (e.g., insurance, asset management), considering the dynamic income and balance sheet adjustments.

D. Liquidity Stress

23. The ECB’s accommodative monetary policy and collateral framework provide banks with abundant liquidity. Liquidity buffers in EUR are high, including central bank, which reserves up to 10 percent of assets. Counterbalancing capacity—the stock of unencumbered assets or other funding sources which are available to cover potential funding gaps—is well diversified under a variety of instruments with strong credit ratings.

24. The overall liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) are adequate for all banks, even though some volatility of the LCR in U.S. dollars has been observed (Figure 26). The structural liquidity ratios—NSFR and LCR—of the banks suggest aggregate liquidity buffers are enough. The LCR is well above 100 percent, although the LCR in U.S. dollars is lower for some banks with volatile flows. Some banks use collateral swaps to improve liquidity positions in U.S. dollars. Similarly, maintaining the NSFR in U.S. dollars appears challenging.

Figure 26.
Figure 26.
Figure 26.

France: Liquidity and Stable Funding

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: COREP reports; and IMF staff estimates.

25. Cash flow analysis implies that liquidity buffers are adequate to absorb shocks over five-day and one-month time horizons, but there are challenges if wholesale funding outflows are large (Figure 27). Banks come out strong under severe liquidity outflow scenarios despite the high share of overnight retail and wholesale funding. However, significant withdrawals of wholesale funding from institutions and corporates do pose vulnerabilities over a short run, including in U.S. dollars. While the liquidity gap in U.S. dollars appears to be manageable (only up to 1 percent of total assets), it could result in contagion risks in case of stress in the U.S. dollar market. The U.S. dollar liquidity/collateral transfer across jurisdictions could also become an issue in times of stress.

Figure 27.
Figure 27.
Figure 27.

France: Liquidity Stress Test

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Source: IMF staff estimates.

26. The authorities are encouraged to consider policies to minimize the impact of potential disruptions in wholesale funding markets including in U.S. dollars. They could consider requirements to hold buffers to cover at least 50 percent of outflows over a horizon of up to five working days from wholesale funding providers in all relevant currencies. These requirements may be linked with monitoring of banks’ use of collateral swaps to improve their liquidity ratios.

E. Insurance Solvency

27. Top-down stress tests focused on market risks. The stress test built on the EU Solvency II framework, covering nine insurance groups on a consolidated basis (accounting for 70 and 40 percent in the domestic life and nonlife gross written premiums respectively). The scenarios were broadly aligned with the banking stress test shocks, but with a greater focus on market risks, including concentrated exposures to domestic banks. Complementary single factor shocks simulating the default of the parent bank shed light on spillover effects.

28. Solvency positions prove resilient under the adverse scenario (Figure 28). The median SCR ratio drops 38 percentage points to 166 percent because of higher bond credit spreads, with SCR ratio at all firms remaining above the 100 percent regulatory threshold. The steepening of the yield curve benefits insurers as the resulting decline in liability valuations exceeds the valuation effect on assets. In general, the impact is more pronounced for insurers with more activities in life business and savings products. Due to a relatively low proportion of guaranteed rates, French life insurers have a relatively high capacity to pass on some of the losses to policyholders.

Figure 28.
Figure 28.

France: Insurance Risk Analysis

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: IMF Staff calculations based on EIOPA and ACPR data.

29. Insurance groups are less vulnerable to a low-for-long scenario than to a combination of higher interest rates and a mass lapse event. The implementation of Solvency II has lengthened investment horizons among French life insurers, so that a low-for-long scenario could be weathered better than in other advanced economies, a finding confirmed by the 2018 European Insurance and Occupational Pensions Authority (EIOPA) stress test. In contrast, French insurance groups face higher solvency and liquidity risks in a scenario of higher interest rates when policy holders have incentives to lapse their policies.

30. Insurers being a part of a conglomerate typically hold very large exposures toward their parent bank, which presents a major channel for the spillover of systemic risks. The market value of on-balance sheet exposures toward the parent bank can reach more than 50 percent of the insurer’s eligible capital. The concentration in deposits held with the parent bank can be very substantial for some insurers. In addition, further financial interlinkages exist, e.g., via derivatives or securities financing transactions.

31. The authorities are encouraged to further monitor insurers’ exposures toward parent banks based on eligible capital, consider the possibility of setting concentration limits, enhance macro stress tests of insurers, and enforce high-quality supervisory reporting. Stress test results should be used to challenge companies’ Own Risk and Solvency Assessments (ORSA) and underlying projections for premium growth and investment returns.

F. Corporate and Households Risks

32. Debt-at-risk would rise under stress scenarios but would be manageable, given the cash buffers available (Table 3).10 Stress test scenarios considered include: (i) a tightening of financial conditions, and (ii) lower real GDP growth consistent with the severity of the bank solvency stress test scenario derived from the 5 percent probability predicted GaR. Under this scenario, the amount of debt-at-risk (ICR<2) would rise to above 11 percent of GDP, because of lower earnings before interest payments and higher cost of debt, but cash buffers appear sufficient to offset the impact of the shock, with debt-at-risk (ICR<2) falling to 7.2 percent.

33. Banks’ large exposures to individual corporates with debt-at-risk would increase significantly under the adverse scenario (Figure 10).11/12 The total banks’ large exposures to corporate debt-at-risk (ICR<2) are on average 11 percent of CET1 capital at end-2017 among six banks. Restricting the sample to corporate with debt-to-equity ratio above 100 percent, the total large exposures remain significant at an average of 6.5 percent of CET1 capital. The total large banks’ exposures to corporate debt-at-risk would rise to about 15 percent of CET1 capital under the cross-country stress test scenario. All exposures of large French banks to individual corporates with debt-at-risk are assessed to be currently below the large exposure limit of 5 percent, but some exposures would rise closer to the current limit under a stress scenario. A joint macrofinancial feedback analysis points to the need to strengthen corporate balance sheets (Box 1).

34. Households’ balance sheet vulnerabilities seem contained in aggregate, though some households may be vulnerable (Figure 29). A closer look at micro data suggests that lower income and younger households with housing loans have experienced some deterioration in their balance sheets; debt service has increased as a share of income while financial buffers have declined.13 Furthermore, younger households appear to have increased their leverage (Figure 28).

Figure 29.
Figure 29.

France: Housing Loan Vulnerabilities

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: ECB Household Finance and Consumption Surveys; and IMF staff calculations.

35. Residential house prices seem aligned with fundamentals, and risks are currently low (Figure 30). Price dynamics are not excessive at the national level, and inflation seems limited to markets such as Paris. The price-to-income and the price-to-rent ratios are above their long-term averages, though deviations are not high compared to peers, and they seem to have improved in recent years. A model of house price at risk adapted from the Spring 2019 Global Financial Stability Report shows that the left tail of the house price distribution has shifted up in recent years, in absolute terms and relative to other countries (Figure 11). Hence, the severity of near-term tail risks in the residential market have declined. However, adverse macrofinancial shocks would significantly shift the distribution of house prices to the left and increase the severity of adverse shocks.

Figure 30.
Figure 30.

France: Real Estate Market

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: INSEE; and IMF staff estimates.

G. Contagion Risks

36. The French banking system remains among the most interconnected in the world, but more diversified since the last FSAP (Figure 31). French banks have become less vulnerable to contagion risks arising from cross-border interbank exposures. French banks have reduced and diversified cross-border exposures in marketable securities, thereby increasing their presence in relatively smaller (less capitalized) banking systems.

Figure 31.
Figure 31.

France: Cross-Border Contagion

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Sources: BIS; and IMF staff estimates.

37. Outward spillovers from France have the greatest impact within the EA, while inward spillovers emanate principally from outside the EA. Within the EA, the Netherlands, Ireland, Belgium, and Italy are susceptible to shocks from France; outside the EA, the United Kingdom is similarly susceptible. France is susceptible primarily to shocks from the United Kingdom, the United States, and Japan. Within the EA, Germany is the primary source of inward spillovers.

38. Inward spillover risks to France have declined since the last FSAP. While the French banking system is susceptible to credit and to credit-and-funding shocks from outside the EA, these have notably declined since 2012 Q4, particularly with respect to the United States. This has translated into an overall lower vulnerability index.

39. It must be noted though that exposures in marketable securities between banks and insurers are not readily accessible. Also missing are exposures in instruments other than marketable securities for all types of financial entities. The partial completeness of the data means that interconnectedness and contagion may be understated. A closer examination of trends within and across financial conglomerates would have necessitated information on which entity-level banks, insurers, and funds (or asset managers) form part of a specific financial group. Nonetheless, the French authorities are making all possible efforts to monitor a broader coverage of exposures and a more complete understanding of cross-sector and intragroup holdings for contagion analysis.

Financial Sector Oversight

A. Cross-cutting Issues

40. Oversight practices maintain their high standards and adaptability to change. Such high quality is essential to mitigate systemic risks given that France is home to so many global systemically important banks and insurers, as well as a large and dynamic asset management sector, implying that realization of risks could have high costs. In recent years, the ACPR and AMF have faced the welcome advent of the SSM and European Supervisory Authorities (ESAs) (Table 7). This has brought some operational challenges including greater demands upon staff, while macroprudential oversight was strengthened.

Table 7.

France: Financial Sector Oversight Structure

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Source: French authorities.1 The ESAs (European Banking Area (EBA), European Securities and Markets Authority (ESMA), European Insurance and Occupational Pensions Authority (EIOPA) also play a role, at the EU level, in microprudential surveillance and risk analysis.2 AMF is responsible for market and business conduct supervision of all market participants.3 To the ESAs, EC, national supervisory authorities and member states.4 The ECB’s SSM has top-up powers over national designated and competent authorities for the use of CRR/CRD IV instruments. EIOPA (art. 16 PRIIPS), ESMA (art. 40 MIFIR) and EBA (art.41 MIFIR) also have targeted macroprudential powers.5 The use of CRR/CRD IV instruments by national authorities requires close interactions with ECB and SSM and might require interactions with other EU bodies for the use of specific powers (e.g., art. 458 CRR). ACPR and AMF also have targeted macroprudential powers (art. 17 PRIIPs, art. 42 MIFIR, art. L.612–1 CMF, art. 124 CRR, art. 164 CRR, art. L.511–41-1-C CMF).6 Single Resolution Board.

41. The ACPR and AMF should have autonomy to determine their own resource levels based on a forward-looking review of current and projected demands. The two authorities lack budgetary autonomy, are bound by legislation to a ceiling on their headcount, governing of fees levied and retained, and (in the case of ACPR) constrained by BdF salary scales. The ACPR and AMF should be allowed to offer more market-based salaries to protect skill sets, and the AMF to retain excess fees. All these are consistent with the expected practices in jurisdictions with large internationally active financial groups, G-SIBs, asset managers, and insurers.

42. In line with international standards consistent with financial systems with internationally active financial firms, reform of governance arrangements is needed. This would further strengthen the oversight of the French financial system and eliminate any perception of conflict of interest. Alternative structures would better support the relationship and exchange of information between the government and the financial supervisors. The government should not be present on any decision-making supervisory committees or colleges of either the AMF or ACPR. While the Loi PACTE has rectified this situation for the AMF’s Sanctions Committee, the AMF should re-assess whether it is appropriate to allow individuals employed by entities supervised by the AMF to sit on that Committee. A short biography of all members of the boards, colleges, and committees of the ACPR should also be published.

43. The functions of resolution and supervision within ACPR require a good level of cooperation and coordination between domestic agents, but critical decision making should stay independent. In the case of insurance, the supervision college has veto power over the resolution college, and the membership of both colleges has overlaps. In accordance with the best international practices and as discussed during the last FSAP, the “perception” of conflict should be avoided.

B. Macroprudential Policies and Tools

44. France has established a macroprudential framework that supports willingness and ability to act. (Table 8 and Figure 32). The HCSF has broad hard and soft powers over tools and warnings, an explicit mandate for financial stability, and can request information from both regulated and unregulated entities.14 The BdF and the ACPR take the lead in producing, on a semi-annual basis, an assessment of risks to financial stability that is discussed at the HCSF meetings.

Table 8.

France: A Comparison of the Macroprudential Tools in Select Countries

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Source: IMF Macroprudential Policy Survey

These broad-based tools are only applicable to the banking sector and in some cases to investment firms.

In Netherlands, the cap on loan to value ratio is only applicable on new residential mortgages.

Figure 32.
Figure 32.

France: Systemic Risk Monitoring—A Four-Block Strategy

Citation: IMF Staff Country Reports 2019, 241; 10.5089/9781513508276.002.A001

Source: French Authorities.

45. It is still too early to determine the real impact of the macroprudential tools applied on bank-based finance thus far. It will be desirable to evaluate the effectiveness and for the HCSF to determine if adjustments are needed to boost banking sector resilience. The reduction in the large exposure limit to 5 percent of bank capital (for large indebted corporates) is an important step as it helps contain a potential rise in the concentration of individual banks’ exposures to large indebted corporates and communicates a need for prudence to market participants. But its scope is limited to large corporates and does not address directly nonbank finance. It has been complemented by a welcome two-step increase in the countercyclical capital buffer (CCyB) to 50 bps to build buffers in the banking system against broader vulnerabilities in the corporate and household sector. However, this measure also does not address risks related to growing nonbank finance in France.

46. France should actively engage at the EU level to broaden macroprudential toolkit for the corporate sector.15 There are few sectoral banking tools for corporates, and no tools to directly address risks from market-based finance at the EU level. The authorities should engage with the ECB on the possible use of Pillar II measures to address residual risks related to corporate exposures. In the event of continued buildup of corporate vulnerabilities in the near term, consideration could be given to the introduction of a sectoral SRB calibrated to corporate exposures. While HCSF has the power to introduce borrower-based tools for corporates, the task of properly designing such tools is inherently challenging. Nevertheless, France should continue to develop an analytical framework for borrower-based tools to address corporate sector risks, including by closely engaging at the EU level.

47. Tax incentives favoring debt to equity should be further weakened. A fiscal measure that incentivizes corporates to finance through equity rather than debt could bring about positive effects for both bank and market-based financing and hence complement the bank-based measures discussed above. The HCSF should recommend the MoF to further weaken the debt bias, if needed, by complementing the already legislated reduction in the Corporate Income Tax (CIT) rate to 25 percent by 2022 with: (i) an interest deductibility based on fixed debt-to-equity rule (i.e., denying interest deductibility if debt-to-equity exceeds some fixed value); and (ii) an allowance for corporate equity, which supplements deductibility of interest with a similar deduction for the normal return on equity.

48. The rise in insurance and asset management business lines also requires macroprudential readiness. While ACPR and AMF are actively monitoring sectoral risks, the macroprudential toolkit in this area remains largely incomplete.16 While this is a global gap, the French authorities could build on the lead taken by them and actively engage at the European and international levels on liquidity and leverage related tools for insurers and investment funds. The ongoing work by the international standard setters could be useful in this regard and advanced.

49. There is scope for strengthening the already strong risk monitoring and reporting requirements. While sectoral risk monitoring is on a good footing, concentrated exposures, which may cause amplification of risks, both at sectoral and at group level, are insufficiently analyzed. Nonbank financial institutions and large exposures between sectors and among FCs should be further incorporated in the HCSF reporting requirements and monitoring of systemic risk. The HCSF should also analyze the transmission of shocks between financial balance sheets within a FC; extend macro stress testing to investment funds and insurance companies; and liquidity stress testing at the conglomerate level. Quarterly or more regular flow data on intragroup transactions in a conglomerate should be reported and the HCSF should consider the development of concentration thresholds for direct exposures within conglomerates and common exposures among entities.

50. Some additional tools could also be brought under the HCSF remit. In line with European legal framework, there are some tools that are entrusted with HCSF’s member institutions with HCSF having limited power to activate them, such as the O-SII buffer, and capital tools on residential or commercial real estate entrusted to the ACPR (Art. 124 and 164 CRR); and leverage limits for investment funds entrusted to the AMF. While the HCSF can issue public recommendations regarding the use of these tools, its powers can be further enhanced with a formal “comply or explain” mechanism.

C. Financial Conglomerates Oversight

51. The legislative framework, the Financial Conglomerates Directive, creates a non-intrusive “aggregation” or “supplementary” approach. While positive, it is insufficient. The framework does not promote active engagement between the sectoral authorities. While the relevant authorities can obtain information on unregulated entities in the wider group, there are no powers to impose conglomerate level prudential requirements. Capital adequacy is assured to the extent that double gearing is avoided, but the framework does not support a consideration of group risks or lead to a conclusion that the solvency of the FC is appropriate and adequate to its risks.

52. Reporting on intragroup transactions and risk concentration is infrequent and, while stress testing is encouraged it is not conducted at FC level. Liquidity is not assessed in the context of the FC. There are no prudential requirements for related party transactions, implying that relationships with connected entities and risk concentrations may be established and reach critical levels without being properly observed. Several of these are gaps in other jurisdictions as well and need a concerted attempt at the global level to secure the safety and soundness of FC models.

53. Recognizing the evolving institutional setup of the BU, progress on some issues can also be achieved through stronger domestic voluntary supervisory coordination. To ensure long-term improvements that apply throughout the EU, however, a broader set of legislative and regulatory changes are needed. An effective EU framework for conglomerate oversight can be achieved by revising the, now dated, Financial Conglomerates Directive.

54. Ongoing changes to the EU regulatory architecture have placed heavy burdens on national competent authorities and the ECB. Understandably, to date the issues of FC oversight have not been a priority. However, it is welcome that, both within the ECB and under the aegis of the ESAs, work is well under way to enhance supervisory guidance and consistency of reporting. These critical objectives are at risk of being undermined if the national competent authorities do not enjoy a degree of operational independence.

55. There should be a greater cooperation and collaboration between the sectoral supervisors. While the work evaluated by the mission was of extremely high quality, the FSAP observed limited supervisory touch points between the authorities. Sectoral supervisors with responsibility for consolidated supervision require financial groups to take account of all the entities within the group. The perspective on group-wide stability and soundness can get distorted if there are gaps. This approach needs to be replicated at the level of the FC itself.

D. Regulated Savings

56. Governance arrangements of the CDC will be enhanced under the Loi PACTE by bringing it formally under the supervision and regulation of the ACPR. These changes are welcome as it is appropriate for the CDC, which is in receipt of public deposits and a full state guarantee, to be within a structure of scrutiny and accountability aligned with prevailing oversight standards in the financial sector. Folding the CDC into the national supervisory framework is consistent with IMF policy advice for state-owned banks.

57. The FSAP identified additional tasks for the authorities to focus on following the Loi PACTE. The first task is to ensure that the ACPR is properly remunerated for its activity and increased burden. Also, the practical and legal arrangements of the state guarantee should be worked out and agreed upon. In addition, given the FSAP’s finding that relates the risk profile of the banking system to its relatively heavy reliance on wholesale funding and weak profitability, the authorities should conduct a review of the regulated savings policy and its impact on the financial system and on affordable housing policies. The FSAP supports the authorities’ efforts to reduce the spread between market interest rates and the rate of return of Livret A, aimed at enhancing monetary policy transmission and improving the allocation of savings and financing of the economy. Given the systemic significance of regulated savings and its direct impact for households and banks, it will be desirable to review the framework and to determine how best to align it with the intended reforms towards promoting market-based savings and financing and deepening of Paris as a key financial center of Europe.

E. Banks

58. The less significant institutions (LSIs) are well supervised by the ACPR under the oversight of the ECB. The LSIs account for only 1.5 percent of French banking assets—excluding a central counterparty and EU branches—and are diversified by size and business model. The LSI sector was resilient during the financial crisis and the ECB has assessed French LSIs to be low risk.

59. Decisions made under national law affecting both LSIs and significant institutions (SIs) have addressed 2012 FSAP recommendations. Notably, the ACPR’s powers regarding major acquisitions have been strengthened, ensuring that it receives prior notification of proposed acquisitions by credit institutions so that it is able to consider them ex ante. While these powers are unlikely to be used in the case of LSIs, the powers add to the armory of the ECB, which has clarified that it is exclusively competent to exercise them in respect of SIs.

60. The weakened powers of the ACPR under national law related to transactions with related parties must be addressed. Before the CRR/CRD IV package, French regulations required related-party transactions that were in aggregate greater than 3 percent of own funds to be deducted from own funds, providing both a limit and a deterrent. The maximum harmonization in the CRR has removed these deductions from national law but no framework—such as large exposure limits—has replaced it. This gap must be remedied as such transactions expose firms to multiple vulnerabilities.

F. Insurance

61. The implementation of Solvency II is progressing well. Solvency II has been implemented since January 1, 2016, as in other EU jurisdictions.17 French insurance companies are significant users of the Volatility Adjustment (VA), with companies representing more than 90 percent of the technical provisions in the French insurance industry using the VA. The French insurance market relies largely on the standard method to calculate the SCR, with only two major (re)insurance groups using full internal models.

62. French and EU authorities should enhance liquidity monitoring. The release of a discussion paper by EIOPA in March 2019 indicates additional reporting on liquidity risk and improved monitoring of liquidity risk are under consideration at the European level for macroprudential purposes.18 ACPR and EIOPA should move toward putting these proposals in place with ACPR encouraged to begin field testing such requirements at the earliest opportunity. In addition, the ORSA and the Solvency and Financial Condition Report (SFCR) should be required to explicitly address liquidity risk in both a quantitative and a qualitative way. The ACPR should continue improving the implementation of ORSA and embedding the ORSA process in insurance company risk culture.

63. To improve the quality of data reporting, annual Quantitative Reporting Templates (QRTs) submitted to the ACPR should be audited. Currently, they are not required to be audited and there is no audit requirement for SFCRs disclosed to the public. In addition, audit assurance processes are recommended to be required for the systems and procedures used to complete QRTs and SFCRs. Furthermore, the ACPR should review the intensity and frequency of onsite supervision and its relationship to offsite supervision. More focused and regular onsite inspections could be envisaged, by adding flexibility in the rules around the frequency of onsite inspections, given offsite analysis may be close to “focused” onsite inspections.

G. Investment Services

64. The French investment services sector is one of the most significant in the EU and is well supervised on a risk-based approach consistent with EU frameworks. It spans the large credit institutions through to small financial advisers consisting of a handful of staff and includes non-French entities benefiting from the EU passport. Both the AMF and the ACPR have put in place a risk-based approach to supervision, and the amount of resources dedicated are commensurate to the associated risks. Extensive cooperation between the national supervisors helps mitigate risks of potential gaps. The implementation of MiFID II and MiFIR has proved particularly challenging to investment firms, and the CMU initiative means that the landscape will continue to evolve.

65. Brexit, combined with the new French regime for crypto-assets, could increase risks to the sector. While the authorities appear well prepared, Brexit could lead to a material increase in the number of investment firms in France in a relatively short period of time. This may exacerbate the resource constraints already faced by the AMF. France has introduced a specific regulatory regime for initial coin offerings (ICOs) and crypto-assets. The new crypto-assets regime appears to strike a sound balance between encouraging innovation and protecting investors. Once the regime is in place, close monitoring will be necessary, with a corresponding increase in supervisory resources.

H. AML/CFT

66. Significant progress has been made in aligning France’s Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) framework with the revised FATF standard and the European AML Directives (AMLD). The Fourth European AMLD has been transposed, including with respect to the risk-based approaches to applying preventive measures and transparency of beneficial ownership. There have been improvements in the legal framework for seizure and confiscation and supervision of nonfinancial businesses and professions. Steps have been taken to strengthen the AML/CFT implementation in France’s overseas territories. France’s first national money laundering and terrorist financing (ML/TF) risk assessment is being finalized. New legislation to strengthen regulation and supervision of activities involving crypto-assets was enacted in April 2019.

67. Although AML/CFT supervision of banks, real estate agents, and company domiciliation agents, to varying degrees, has targeted higher-risk entities or areas, lawyers are subject to little AML/CFT oversight. The ACPR assesses ML/TF risks of individual banks, but in practice, its onsite inspections concentrate on large financial groups. There is a need to increase oversight of smaller banks rated as high-risk and speed up issuing penalties. Systematic ML/TF risk assessments of real estate agents and company domiciliation agents would better inform the focus and scope of supervision and the resources needed. To enable effective AML/CFT oversight of lawyers, the National Bar Council should work with local bar associations in promoting unified understanding of ML/TF risks and developing consistent approaches to a risk-based monitoring program, procedures, and disciplinary actions.

68. Steps have been taken to improve prevention, detection, investigation, and prosecution of TF, as well as ML with a cross-border dimension, but there is room for improvement. Financial intelligence from Tracfin has been used extensively in the investigation and prosecution of TF cases, which has resulted in the identification and investigation of several networks funding terrorist activities, and over a hundred TF convictions secured between 2010 and 2017. The National Financial Prosecutor was created to focus on financial crimes, particularly those with an international dimension. These efforts will benefit from more systematic guidance on TF to reporting entities and strengthened oversight of and more guidance to sectors most exposed to cross-border ML risks.

Crisis Management and Safety Nets

69. France is better placed today to manage a crisis. The ACPR acts as the Resolution Authority (RA) for banks, insurers, and investment firms. It can start liquidation procedures for institutions under its supervision. Arrangements at the EA level are allowing national authorities to refocus their oversight towards LSIs. The BdF and Fonds de Garantie des Dépôts et de Résolution (FGDR) play a critical role in terms of Emergency Liquidity Assistance (ELA) provision, deposit insurance and investor protection; policyholder protection of insurance contracts is mainly in the hands of two policyholder protection schemes (PPSs). Regarding inter-agency crisis preparedness, the HCSF does not have a specific function, but its mandate supports inter-agency policy coordination.

70. France is one of the first systemically important jurisdictions to establish a comprehensive resolution framework for insurers. The framework based on the Sapin II law, enacted in December 2016 and Ordinance 1608 of November 2017, provides for a broad set of new resolution tools, such as transfers of assets and liabilities, and bridge entities, but does not include a bail-in tool. The framework applies to all insurance entities subject to Solvency II, except for the part on recovery and resolution planning (RRP), which currently applies only to 14 insurers covering a large share of the market. The resolution framework is designed to apply to insurers that breach capital requirements, while remaining balance sheet solvent in a Solvency II sense (i.e., assets still cover liabilities). In case of insolvency, the framework leads to liquidation.

71. To better align the insurance resolution framework with the Key Attributes, further work is needed in some areas. The resolution framework for insurers should have additional tools (notably, bail-in), safeguards, and legal protection of contractors, and a scheme for privately financed resolution funding). The overall preparedness would benefit from tests and simulation exercises at various levels. With respect to resolution funding, the Fonds de Garantie des Assurances de Personnes (FGAP) and Fonds de Garantie des Assurances Obligatoires de dommages (FGAO), the two PPSs, have a narrow scope of work as they are not prepared to support resolution processes, only compensation under liquidation procedures.19

72. Crisis preparedness has been enhanced by the ongoing RRP exercises, but the resolution and supervision colleges need greater independence. The RRP cycles are more advanced for bank SIs, followed by those for LSIs, and are at an early stage for insurers. Recovery plans are gradually improving and becoming more focused on key elements, including governance and feasibility of the recovery options, though operationalization and quantification of recovery options are aspects for further development. Regarding LSIs, the strategy is to opt for liquidation in cases of failure. The assessment of RRPs has improved coordination between ACPR’s Supervision and Resolution Departments. The membership of the supervision and resolution colleges have significant overlaps, and for an entity under ACPR’s remit to be declared as failing or likely to fail the resolution college must consult the supervisory college, which amounts to a veto. This feature could raise concerns about independence and the possibility of supervisory forbearance. Moreover, France chose not to adopt financial stabilization tools available under the BRRD, which would be helpful to manage system-wide crises. Finally, ACPR needs to deploy enough resources for RRP, particularly for insurers.

73. Regarding deposit insurance, the FGDR design is well aligned with EU standards, both as a deposit guarantee scheme and as a resolution fund, but the Supervisory Board membership needs reform. The governance of the FGDR includes a Supervisory Board composed of 12 active financial sector executives and an Executive Board that deals with day-to-day decisions. There is a separation of functions between both levels of authority and there are specific practices geared to avoid conflict of interest. However, in line with good practices, the eligibility for Supervisory Board membership should be changed to include only independent members. The FGDR also manages the investor protection scheme, which covers retail investors from losses due to fraud and operational risk by investment service providers. The resolution fund, covering a subset of LSIs, is on track to reach its funding target by 2024 and could be tapped to support the application of Bank Recovery and Resolution Directive (BRRD) resolution tools. The FGDR is represented in the resolution college when it must decide on the resolution modality for entities under its remit (LSIs, insurers, and investment service providers).

74. The BdF ELA scheme, which is well aligned with the euro system framework, would benefit from enhancements. Given the importance of FX wholesale funding in the banking system, establishing mechanisms and rules regarding ELA in FX is an avenue that needs to be explored while addressing the feasibility of advance agreements and the conditions for swap lines for this purpose. Also, ELA can be provided to a bank in resolution, but to anticipate cases in which ELA collateral would be insufficient, the BdF could establish rules to help banks (i) identify in advance which assets in their balance sheets might be proposed as ELA collateral, and (ii) to buttress their operational readiness to pledge them. At the same time, contingent arrangements, such as a public guarantee at the national or European level under strict safeguards could add readiness to the ELA scheme, which would be admissible under state aid rules revised as recommended by the EA FSAP.20

75. An important challenge is to ensure preparedness to deal with failure of a conglomerate. In the medium term, RRP exercises should incorporate the intra-conglomerate dimension, including for safety net arrangements. By checking the separability of business units, the resolvability analysis will partly cover these aspects, but more can be done in full coordination with EU institutions. Authorities need to ensure operational readiness and conducting intra and inter-institutional crises simulations and tests would help identify potential gaps.

Gap Analysis of Default Risk and Capital of Nonfinancial Corporates and Banks

The model examines default risks and aggregate capital of the sectors relative to their potential levels. Similar to the concept of output gap between sticky and flexible prices, risk gaps and capital gaps between sticky and flexible capital structure (potential) are calculated. The model used for the FSAP captures various feedback effects between the sectors. Risks are elevated (positive risk gap) during four periods: the 2002 technology crisis, the 2008 GFC, the 2012 European sovereign debt crisis, and present.

Applying the same shocks that occurred during the 2008 GFC shows that corporate balance sheets are more vulnerable than those of the banks. In particular, the results show that default risk of the nonfinancial corporate sector is high and capital low, both relative to their potential levels, while bank default risk and aggregate bank capital are closer to their potential levels.

Source: IMF staff calculations.Note: The figure shows gaps of default risk and aggregate capital of the nonfinancial corporate sector and the banking sector. A positive risk gap marks periods with too much risk relative to potential. A positive capital gap marks periods with too little capital relative to potential. When risk is too high (positive risk gap), capital tends to be too low (positive capital gap). The x-Axis denotes the year. The y-Axis denotes percentages (in the case of risk 0.005 equals to 0.5 percent excessive default risk in absolute terms; in the case of capital 0.2 equals to a 20 percent gap relative to the nominal amount of aggregate capital). The grey bars highlight recession periods of France’s economy. The dotted red line simulates a crisis period that is in magnitude like the global financial crisis.

Appendix I. Implementation of 2012 FSAP Recommendations

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