French banks have taken a bit of a battering in the past few weeks, with the quarterly results for Societe General revealing a slump in earnings, and Credit Agricole expected to report a 750m euro loss in their Q4 report tomorrow. BNP Paribas also reported a fall in earnings, although it was by less than many were predicting.

This paints something of a mixed picture, with a lot of uncertainty. However, for those investors who don't mind taking a risk or two, French banks might actually be quite a good bet.

The reasons for this are twofold. Firstly, core earnings appear to be on the way up, and secondly, concerns about the quality of the loan book may be misplaced.  While the returns are low, the risk level may decline, which would make those low returns seem a lot more attractive.

Core earnings are building momentum

Firstly, let's look at core earnings, or net interest income. They appear to be headed in the right direction, as is net income. This is on the back of increasing margins on deposits and loans, which don't necessarily take into account a rapid credit expansion.

One of the main concerns of investors is the quality of the loan book, which some analysts think has peaked in 2011, and the diminishing return on equity (ROE) which they say will contract considerably in the years to come. This lower ROE makes investment in banking shares less attractive in relation to other assets.

On the other hand, if the risk level also goes down, that could change things.  New capital regulations are on the way that will place limits on risk, and this is why French banks could be a good investment in the future.

Trading income fading away

The French banks were particularly dependent on trading income, and this has hurt them over the past couple of years. Nearly all banks globally grew fat on trading income, and during the boom years this could account for around 30-50% of their overall result. Now banks all over Europe and the US are currently experiencing a painful "detoxification" to lower risks.

Trading income has fallen dramatically in the last years and are expected to stay that way for the next three years. In order for French banks to come back from last year's slump, they will need to find a way to offset the lower trading income. While the future is never certain, we think they will!

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