Despite France's credit rating being downgraded from AA- to A+ in September 2025 by Fitch, then in October 2025 by Standard & Poor's, France is still considered a ‘risk-free’ borrower in the balance sheets of banks and insurers. Why is there such a discrepancy?
On Friday, 12 September 2025, Fitch downgraded France's credit rating from AA- to A+ after the markets closed. Symbolically, this was a serious blow. For the first time in more than ten years, France lost its ‘double A’ rating. And yet, on the following Monday, nothing had changed: the CAC 40 was up and France's credit spreads were stable.
The same thing happened again a month later: on 18 October, Standard & Poor's (S&P) also downgraded France's rating to A+. Once again, there was no significant reaction from the markets – neither in bond spreads nor in the CAC 40 index. On 24 October, Moody's placed France's AA- rating on negative outlook.
The common explanation? The markets had already anticipated these decisions. But is that really the whole story?
In this article, we explain why, both in the context of banking regulations (Capital Requirements Regulation, CRR) relating to capital requirements and insurance regulations (Solvency II), France is still considered a borrower that falls within the definition of a ‘risk-free’ country.
This may help to explain the limited impact to date of successive downgrades by Fitch and Standard & Poor's, while highlighting that the banking and insurance mechanisms at work can suddenly turn into a guillotine.
Ratings vs. grades
Under standardised approaches, European prudential regulations (primarily 2024/1820 and 2024/1872) do not work directly with alphabetical ratings, but are based on credit quality steps (CQS). These steps are general categories that group together several ratings:
– CQS 0: AAA (Solvency II only; CRR does not include level 0), such as Germany, Switzerland, Denmark, the Netherlands or Sweden.
– CQS 1: AAA to AA- (CRR)/CQS 1 and AA+ to AA- (Solvency II), such as Austria, Finland, Estonia, Belgium and the Czech Republic.
– CQS 2: A+ to A-, such as Slovenia, Slovakia, Poland, Lithuania and Latvia.
– CQS 3: BBB+ to BBB-, such as Italy, Romania, Bulgaria, Croatia, or Hungary.
– CQS 4-6: speculative ratings (BB+ and below), such as Serbia, Montenegro, North Macedonia, or Kosovo.
Technically, according to banking and insurance regulations, Fitch's downgrade of France's rating in September 2025 could have caused it to drop from CQS 1 to CQS 2. But this is not the case.
Until October 2025, when Standard & Poor's downgraded France's rating, both regulatory frameworks continued to treat France as a very high-quality issuer, i.e. ‘AA’ rather than ‘A’. This is due to the way in which the regulations treat multiple ratings: neither banks nor insurers automatically use the lowest rating.
Second-best rating rule
Under European banking and insurance regulations, the second-best rating rule applies.
For example, if a debtor is rated by three agencies (S&P, Moody's, Fitch), the highest and lowest ratings are discarded, and the middle rating is retained. As long as two of the three agencies maintained France in the AA category, the benchmark rating for regulatory capital purposes remained CQS 1.
In other words, even after Fitch downgraded France to A+, regulators continued to classify France as ‘AA’. It was only after S&P's downgrade on 17 October 2025 that France effectively moved to CQS 2. Moody's, for its part, maintained its AA- rating but placed it on negative outlook on 24 October – a warning sign, certainly, but with no regulatory consequences at that stage.
Not all downgrades are equal. Some immediately change the way European financial institutions have to treat risk. Others, however, have no operational effect. And yet, none of them really caused the markets to react.
Regulatory illusion of safety
For most debtors, such as companies or financial institutions, moving from one credit quality step (CQS) to another has a direct impact on capital requirements. In the specific case of European sovereigns, even an official move to CQS 2 is of little significance.
Under current rules, European Union sovereign bonds denominated in their own currency have a risk weighting of 0%. Why is this?
In practice, banks are not required to set aside capital to cover the risk of default on French loans denominated in euros, regardless of the rating assigned to this debt by rating agencies.
Similarly, insurers holding bonds issued by European Union Member States (denominated in their own currency) are not subject to any capital requirements to protect themselves against potential default on these securities.
The only capital requirements for these bonds arise from so-called ‘market’ risks: interest rate risk, i.e. the potential loss associated with a rise in interest rates, and foreign exchange risk, in the event of unfavourable movements in foreign currencies. No capital is required for credit spread, i.e. the risk that the market will demand a higher premium to lend to the government.
Loans to the UK – or any other European sovereign in its national currency – are considered credit risk-free. This framework was designed to avoid fragmentation and treat the public debt of any European Member State as the basis of the financial system, regardless of the individual situation of each country.
Systemic paradox
The markets already distinguish between sovereign states. Spreads are widening, credit default swap (CDS) prices – which allow investors to insure themselves against the default of a debt issuer – are rising, and investors are demanding a premium for weaker credits, well before any downgrade is official.
From a regulatory capital perspective, the existing framework leaves no room for a gradual distinction within the European Union. The consequence is clear: European sovereign states are considered ‘safe’ by definition, until they are no longer so...
This creates a kind of organic ‘cliff effect’. As long as institutional confidence remains sufficient, regulation partially mitigates the recognition of risk. Once a threshold is crossed – often a confidence threshold, rather than a purely accounting one – the correction becomes brutal. What should be a gradual revaluation turns into a systemic breakdown.
Fifteen years ago, the public debt crisis in Greece was enough to trigger a Europe-wide crisis. Today, France reminds us that the very architecture of European regulation makes its financial stability less gradual than binary. As long as the markets believe in it, everything holds together. But if confidence were to slip, it would not only be France that would falter – it would be the whole of Europe.
This article by Rémy Estran, CEO – Scientific Climate Ratings, EDHEC Business School, has been republished from The Conversation under a Creative Commons licence. Read the original article (in French).
