REGULATORY RATIOS APPLICABLE TO THE FRENCH BANKING SECTOR

According to the provisions of the French Banking Act (dated 24th January 1984), "credit institutions shall be required, subject to conditions laid down by the "Comite de la Reglementation Bancaire", to observe management standards designed to safeguard their liquidity and solvency in relation to depositors and, more generally, third parties, and the balance of their financial structure. They must in particular observe risk-asset and risk-diversification ratios" (art.51).

Enforced by the Banking Act or by specific regulations, the main ratios applicable to French banks are the following : the French solvency ratio; the risk ratios including the risk-division, the monitoring of interbank counterparty risks and the monitoring of foreign exchange positions ratios; the liquidity ratio; and the equity and long term resources ratio.

These ratios will be described here, after defining the equity that is used in their calculation.


THE REGULATORY DEFINITION OF EQUITY

A definition of equity is set out in regulation CRB nr. 90-02. This definition is applicable to the calculation of all prudential ratios, except the equity and long term resources ratio.

The total equity shall comprise the sum of what is called "basic" equity, as defined in the aforementioned regulation, and "supplementary" equity, within certain limits, after deduction of equity holdings in financial institutions and subordinated claims.

The basic equity:-

The basic equity includes the following items (added or deducted, depending on whether they are credits or debits): the capital (after deduction of unpaid capital); the legal reserve, statutory reserves, and reserves other than re-evaluation reserves; the paid-in capital; the unappropriated retained earnings; the net income for the period, verified by the auditors; the general reserve for banking risks.

Moreover, when calculated on a consolidated basis, the equity shall include : the goodwill; the difference on securities consolidated by the equity method; the foreign exchange translation differences; the minority interests.

Lastly, the treasury stocks held by the bank as well as the intangible assets (including the start-up costs) shall necessarily be deducted from the net "basic" equity.

The supplementary equity:-

Included in this category are :

- the re-evaluation reserves and differences, resulting from legal or regulatory re-evaluations.

- certain items that can be freely used by the bank to cover losses, not yet identified, related to normal banking activity, provided that they are booked in the bank's accounts and that their amount is set by the bank's management and checked by auditors. Falling into this category : fully mutualised guarantee funds; other guarantee funds and public funds allocated to cover credit risks (limited to 8% of the risk-weighted assets they cover); non-repayable public or private subsidies; reserves related to leasing operations.

- "hybrid instruments", i.e. funds deriving from the issue of securities of indeterminate duration or from loans meeting certain conditions (including the fact that they can only be repaid on the initiative of the borrower, the latter has an option to defer the interest payment, and that the lender's claim is subordinated).

- subordinated term debts.

The supplementary equity can be taken into account within a limit of 100% of basic equity. Moreover, an additional limit is set on the subordinated term debts, that should not exceed 50% of basic equity.

Deduction of equity holdings and subordinated claims:-

The subordinated claims and the equity holdings in financial institutions shall be deducted from the equity.

For the equity holdings exceeding 10% of the owned financial institution's capital or giving a significant influence over the institution, the total amount should be deducted. For the other shareholdings, only the amount exceeding 10% of the parent company's equity (before the said deduction) shall be deducted.


THE FRENCH SOLVENCY RATIO

Regulation CRB 91-05 stipulates that "credit institutions and securities houses ... shall observe at all times a solvency ratio (amount of their equity expressed as a proportion of their aggregate credit risk exposure as a result of their operations) of not less than 8%".

This ratio shall be reported to the Commission Bancaire twice a year. It shall necessarily be computed on a consolidated basis, whenever the institution controls or has a significant influence over one or more financial institutions.

The denominator of the ratio includes all on-balance-sheet assets and off-balance-sheet commitments given. These items must be risk-weighted according to three series of criteria :

1) their nature :

A simple weighting shall be directly applied to the on-balance-sheet items.

For the interest rate and foreign exchange off-balance-sheet commitments, the instruments should be :

- first revalued, either by calculating their market value plus a fixed percentage of their notional amount, or by taking into account their initial risk in applying a fixed percentage to their notional amount (from 0.5% to 1% for the interest rate instruments, and from 2% to 5% for the FX instruments);

- then weighted according to the counterparty.
For the other off-balance-sheet-commitments, the amounts are :
- first weighted according to the risk related to the type of commitment (for instance 0% for unutilised overdraft facilities, 20% for documentary credits),
- then weighted according to the counterparty.

2) the nature of the counterparty : central governments and central banks; institutions of the European Community; regional or local governments; credit institutions; clients.

3) the geographical area : OECD and the rest of the world.

The risk-weightings for the various combinations of the above-mentioned criteria are 0%, 20%, 50% and 100%.

The Cooke ratio is applicable in France to the institutions having significant international operations. Although some discrepancies with the French solvency ratio exist, they tend to disappear progressively, so that their computation becomes more and more consistent.


THE RISK RATIOS

The risk-division ratio (CRB 84-08)

All credit institutions shall maintain at all times, and report quarterly to the Commission Bancaire :

- a maximum ratio of 40% between their overall exposure per beneficiary and their equity;
- a maximum ratio of 800% between the aggregate of their large exposures (i.e. where the exposure on a single client exceeds 15% of equity) and their equity.

These ratios shall be computed on a consolidated basis. The notion of "beneficiary" shall be construed as a counterparty or a group of counterparties, whenever there is a control over other entities. The exposure includes the risks over clients and foreign financial institutions, and covers credits, leasing, securities transactions, and off-balance-sheet commitments. It is a weighted exposure, where the weightings vary depending on the type of transactions and counterparties.

The monitoring of interbank counterparty risks (CRB 90-07)

All banks shall set up a monitoring system for interbank counterparty risks, including limits for each banking counterparty in relation to their equity.

No formal ratio or reporting requirement is set up by this regulation. However, the banks shall provide the Commission Bancaire, upon request, with their largest off-balance-sheet and on-balance-sheet exposures, and, if applicable, all excess over their internal limits.

The monitoring of foreign exchange position (CRB 89-02)

The financial institutions shall observe at all times, and report quarterly to the Commission Bancaire:

- a maximum ratio of 15% between the weighted amount of their long or short position in each foreign currency and the amount of their net equity;
- a maximum ratio of 40% between the largest total weighted long or short positions in all currencies and the amount of their equity.

A 30% weighting shall be applied to the positions denominated in ECU or in an EMS currency, and 100% for the other currencies.


THE LIQUIDITY RATIO

The financial institutions shall observe a liquidity ratio, and several "observation ratios" reflecting their forecasted liquidity position (CRB 88-01), and report them quarterly to the Commission Bancaire. They can be calculated on a consolidated basis.

The liquidity ratio is the ratio between their short term and liquid weighted assets and their short term and exigible weighted debts, and should not be less than 100%. The treasury balance, as defined below, shall be added to the numerator when it is a debit and to the denominator in the opposite case. The treasury balance is defined as the sum of 100% of equity plus debit balances minus credit balances of certain weighted items including : cash, trading securities, demand and time accounts of less than one month of maturity, etc.

The liquid assets include credits (except those with an undetermined maturity), leasing, securities transactions (except own shares and investment securities), collection accounts and standby credits. The short term debts include demand and time deposits, savings accounts, notes and certificates of deposit, collection accounts, bonds issued, and certain off-balance-sheet commitments.

The observation ratios are calculated like the liquidity ratio (although some weightings are different), but for the assets and liabilities with a maturity respectively between 1 and 3 months, between 3 and 6 months, and between 6 and 12 months.


THE EQUITY AND LONG TERM RESOURCES RATIO

The financial institutions shall observe a minimum ratio of 60% between their equity and long term resources (with a maturity exceeding 5 years) and their long term assets (CRB 86-17). It should be noted that the definition of equity used in this calculation is different from the above-mentioned. This ratio is reported annually to the Commission Bancaire.

In conclusion, it can be noted that the main current issue relating to prudential ratios in France concerns the EC directive on market risks (EC 93/6). This directive sets capital adequacy rules in respect of capital markets risks undertaken, including "position" risk (variation in prices), delivery risk and foreign exchange risk. This directive has not yet been enforced into French banking regulations, but it should be done by the end of this year.

For more information, please contact Olivier Durand or Olivier Drion on (33) (1) 42 91 08 16.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.