Who Has Financial Exposure to French Debt?

Executive Summary

French voters go to the polls in late April and early May to elect the 10th president of the Fifth French Republic. If elected president, Marine Le Pen, who is the leader of the National Front, wants to take France out of the Eurozone and bring back the French franc as the country’s currency. A re-introduced franc likely would depreciate sharply vis-à-vis the euro, which could entail financial losses for holders of euro-denominated French debt. Our rough estimates show that financial institutions in the United Kingdom and Germany likely would be among the foreign creditors who would have the most to lose in this scenario.

Even if Le Pen wins the French presidency, a French exit from the Eurozone might not occur for a number of years because she could not unilaterally take France out of the euro area. However, a victory by Le Pen would raise the prospect of an eventual French exit from the Eurozone, which would call into question the very survival of the euro area. In that event, financial assets in “peripheral” European economies (e.g., Greece, Italy, Portugal and Spain) could experience significant selling pressure. In short, the financial market turbulence associated with the European sovereign debt crisis of 2010-2012 could rear its ugly head again if Marine Le Pen is elected as the next president of France.

Le Pen Would Seek to Bring Back the French Franc

French voters go to the polls on April 23 and likely will return for second-round voting on May 7 to elect the country’s next president.1 Although victory by Marine Le Pen, who is the leader of the anti-EU, anti-immigrant, populist National Front is seemingly unlikely, it would be naive to completely dismiss her chances. Le Pen would be a transformative president because her platform includes a French exit from the Eurozone and perhaps from the European Union. Le Pen wants to bring back the franc as the national currency of France and she has said that she would allow it to float freely in the foreign exchange market. A freely floating French franc likely would depreciate sharply. Although franc depreciation would ultimately provide a boost to French exports, it could also entail financial losses for owners of French debt.

French assets and liabilities currently are denominated in euros. Redenomination of these assets and liabilities into francs would not have any direct financial fallout if both creditor and debtor were located in France. However, consider a scenario in which a German bank has extended a euro-denominated loan to a French company and the franc depreciates 25 percent vis-à-vis the euro. The German bank would suffer a 25 percent reduction in the value of its asset if the French company is allowed to make payment in francs. Conversely, the French company would realize a 25 percent increase in the franc-value of the loan if it needs to repay the loan in euros. Although the German bank would not suffer an initial loss in this scenario, it could eventually realize a loss if the French company were to become insolvent due to the increase in its franc-denominated liabilities. Moreover, owners of French debt securities would suffer mark-to-market losses if the prices of those assets were to fall.

In our view, it is prudent to ascertain which countries have the most financial exposure to France, and thereby potentially the most to lose, ahead of the French presidential election. In the event, however unlikely, that Le Pen becomes the next president of France, prices of French assets could fall significantly. In the rest of this report we use a number of different data sources to ascertain which countries would potentially have the most to lose financially from a victory by Madame Le Pen.

France Has a Significant Amount of External Debt

Data that are compiled by Eurostat show that the total amount of debt owed by French residents has grown from to €8.6 trillion today from €3.3 trillion in 1999 (Figure 1). Among sectors, the non-financial corporate (NFC) sector in France has the most debt at €2.8 trillion in Q3-2016. The outstanding debt of the general government is a close second at €2.5 trillion, the financial sector has €2.0 trillion worth of debt, and the debt stockpile of the French household sector stands at €1.3 trillion. Expressed as a ratio of GDP, total French debt has risen to roughly 385 percent today from about 240 percent in 1999.

So, who holds this debt? Available data do not allow us to provide a complete and precise accounting by country, but we can derive some general estimates. Data from the World Bank indicate that 57 percent of French debt is external debt. That is, 57 percent of the total debt of the French household, business and public sectors is owned by foreigners. That ratio may seem high until one considers that the French economy has extensive trade and financial ties with other countries, especially with its neighbors in Europe. Moreover, France’s external debt has grown from €3.5 trillion in 2008, when the data series starts, to about €4.9 trillion today (Figure 2).

The remaining 43 percent (about €3.7 trillion) of total French debt is owed to other French residents (households, financial corporations and non-financial corporations). As noted above, redenomination of French assets and liabilities from euros into French francs would not have direct effects on the French institutions, which have extended credit, either via loans or via purchases of debt securities, to French debtors. That said, there may be indirect effects for these French institutions if an exit from the Eurozone were to significantly weaken the French economy and the ability of French debtors to repay their franc-denominated debt.

Which Countries Have the Most Bank Exposure to France?

Returning to France’s external debt, we know that €4.9 trillion of French debt is owed to foreign creditors. These creditors would include foreign banks as well as foreign non-bank financial intuitions (NBFIs) such as foreign insurance companies, pension funds, and hedge funds, etc.

Data compiled by the Bank for International Settlements (BIS) show that exposure by foreign banks to France totaled about $1.6 trillion (roughly €1.4 trillion) at the end of Q3 2016 (latest available data). 2 Total bank exposure includes the loans that foreign banks have made to French residents as well as the French debt securities that those banks own.

Figure 3 shows the 10 foreign countries with the most bank exposure to French households, businesses and government. Collectively, these countries account for 85 percent of the total exposure that foreign banks have to France. Among foreign banks, U.K. banks have the most exposure to France (more than $400 billion) followed by Germany ($215 billion) and Japan ($190 billion). American banks have only $85 billion worth of exposure to French households, businesses and government.

British, German and Japanese banks have the most absolute exposure to France, but banks in these countries tend also to be large. Exposure to France via debt instruments (both loans and debt securities) accounts for nearly 6 percent of British banking system assets. The comparable ratio for German banks is 2.4 percent and 1.6 percent for Japan. The American banking system has only 0.5 percent of its assets exposed to French debt.

What About the Exposure of Other Financial Institutions?

So, that leaves about €3.5 trillion (nearly $4 trillion) worth of external debt exposure to France that is held outside of foreign banks (i.e, held by non-bank financial institutions in foreign countries). As noted above, we cannot pinpoint where the total amount of this debt is held. However, data from the International Monetary Fund (IMF) identifies about $2 trillion worth of holding by French debt securities in foreign economies. According to the partial IMF data, the countries with the most individual exposure to French debt securities at the end of Q2 2016 (latest available data) were Germany and Japan, which each held more than $300 billion. The United Kingdom held more than $200 billion, while the United States owned more than $150 billion worth of French debt securities.

However, the IMF data include the holdings of French debt securities by foreign banks and foreign NBFIs in combination. Unfortunately, we do not have a country breakdown showing the amount of French debt securities owned by foreign banks and the amount owned by foreign NBFIs. If we simply add the amount of exposure that foreign banks have to France (Figure 3) to the ownership breakdown that is contained in the IMF data, we would be double counting the French debt securities that foreign banks own. Using a simplifying assumption, however, we can estimate of the amount of French securities held by foreign banks and then derive estimates of total country exposure to French debt.3 These estimates are shown in Figure 4.

Not only do British banks have more than $400 billion worth of exposure to French debt instruments, but we estimate that NBFIs in the United Kingdom own about $100 billion worth of French debt securities. Therefore, we estimate that the exposure of British financial institutions to French debt total about $500 billion. In other words, British financial institutions (both banks and NBFIs) could experience significant financial losses in the, admittedly unlikely, event that France exits the Eurozone. We estimate that German and Japanese financial institutions could also experience meaningful losses as well. Unlike the British financial system, where exposure to France appears to be concentrated among banks, NBFIs in both Germany and Japan appear to own French debt instruments in roughly the same amount as banks in those countries. We estimate that American banks and NBFIs together own about $200 billion worth of French debt.

We should stress that the estimates shown in Figure 4 should not be taken too literally. That is, the absolute amounts of exposure that are shown in Figure 4 should be treated as rough estimates only. First, we had to make a simplifying assumption, which may or may not be entirely valid, to come up with our estimates of French debt securities that are owned by NBFIs in foreign economies. Second, we are unable to account for the entire €4.9 trillion worth of French external debt. As noted above, the IMF data on foreign holdings of French debt securities are incomplete— not all countries participate in the survey—and data on Chinese exposure to France, which do not appear in Figure 3 or Figure 4, are only partial. More complete data sources could alter our estimates of country exposure to French debt.

Although our estimates may be rough approximations, they may be useful when comparing relative exposure amounts. That is, it probably is reasonable to state that the United Kingdom and Germany have more overall exposure to French debt than do, say, the Netherlands or the United States. Consequently, the United Kingdom and Germany may be among the foreign economies with the most to lose directly from any financial market fallout associated with the potential (unlikely) election of Marine Le Pen as the next president of France.

Conclusion

France will hold arguably its most important presidential election in decades in late April and early May. A victory by Marine Le Pen, although seemingly unlikely, could have far reaching consequences because she wants to pull France out of the Eurozone and perhaps out of the European Union. A reintroduced French franc, which is one of Madame Le Pen’s policy proposals, likely would depreciate sharply against the euro. Foreign owners of French debt, which currently is denominated in euros, could suffer direct and indirect financial losses as the franc depreciates vis-à-vis the euro. Our rough estimates suggest that financial institutions in the United Kingdom and Germany would have the most to lose under this scenario.

Even if Le Pen wins the French presidency, a French exit from the Eurozone might not occur for a number of years because she could not unilaterally take France out of the euro area. Although an exit from the Eurozone would not require a change to the French constitution as an exit from the European Union would, the French parliament would need to approve legislation taking France out of the euro area. However, a victory by Le Pen would raise the prospect of an eventual French exit from the Eurozone, which would call into question the very survival of the euro area. In that event, financial assets in “peripheral” European economies (e.g., Greece, Italy, Portugal and Spain) could experience significant selling pressure. In short, the financial market turbulence associated with the European sovereign debt crisis of 2010-2012 could rear its ugly head again if Marine Le Pen is elected as the next president of France.