France’s biggest two banks have re-invented themselves as big international players and derivatives houses. But last week it was their traditional domestic franchises that hurt their share prices. BNP Paribas said fourth quarter French retail revenue had only grown by 2.6 per cent year-on-year, after stripping out a one-off gain in 2005. Société Générale booked 3 per cent growth. In the first three quarters, both lenders exhibited an average growth rate of 9 per cent.

Loan books are still growing healthily and provisions remain low. But net interest margins are falling, from 3.23 per cent in late 2004, in SocGen’s case, to 2.72 per cent. About half of this reflects higher base rates. The impact of a flatter eurozone yield curve is not uniform – Spain’s banks are reporting improved margins. But with many deposit accounts regulated, French lenders have to pass through rate increases quickly. The rest of the margin squeeze is largely because loan growth exceeds deposit growth, forcing banks to tap more expensive funding from capital markets.

Both BNP and SocGen expect revenue at their French retail units to grow by about 4 per cent in 2007 and emphasise the opportunities to boost non-interest income. Investors are sceptical. The drag of existing regulated rate increases will not end until August. More pressure will arise if eurozone base rates rise further. Ultimately, asset growth may have to slow if margins remain tight. BNP says its 9 per cent loan book growth, below SocGen’s 14 per cent, partly reflects its relative caution.

The bigger picture is that French retail is a quarter or less of net income for both companies, with booming but fickle investment banking having a growing weight. Still, BNP and SocGen need to persuade wary investors that the decline in France’s contribution does not indicate a diminution of earnings quality.

One easy solution exists: raising dividend pay-out ratios, which are both below 50 per cent.

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