Rumors have been circulating for some time about the health of French banks. Those rumors play a huge part in the recent surge in worries about the creditworthiness of the French state. After all, the Irish banks came pretty close to bankrupting Ireland. The British banks knocked a huge hole in the British government balance sheet. And French banks have huge exposures to Greece, Italy and Spain, which calls into question how safe they are.

Since France has high government debt, a gaping deficit, and a seeming incapacity to balance its budget, those questions are pressing now in a way they haven’t been for thirty years.

So I thought I’d call a contact of mine – a highly placed source in the interbank markets and a person who has his finger on the pulse of who’s lending what to whom. What he had to tell me was shocking:

• Two to three months ago, lenders unofficially suspended their trading lines to French banks. It wasn’t like the panic of 2008, when people rushed to sell their risk at whatever price they could get. It’s been slower than that, but more insidious. When loans mature, they are not being renewed. In effect, it’s become almost impossible for French banks to sell their long term paper [ie: to raise money by selling Certificates of Deposit or IOUs.]
• Some of the major French lenders are offering interest rates at twice the going rate in the market for other credits- yet there are very few buyers of their paper, even so.
• What little lending is still taking place tends to be for very short dated maturities – that is, French banks can still borrow for up to 10 days, but are very pressed to borrow in ANY significant amounts for three months or longer.
• Loan volumes have also plummeted. Where once traders were doing deals in the €200-300 million per deal bracket, now they’re more likely to be doing tickets in units of €20-30 million, if they are lucky. For larger institutions, who previously dealt in amounts of €2,000-3,000 million, volumes have been pegged right back to €200- 500 million.

I asked about UniCredit – the Italian bank we wrote about here – and he laughed. He said to me, ‘UniCredit has no buyers in the interbank market at all’. I suspect that was a slight exaggeration, but only slight.

The simple, sombre fact is that the European banking system is in crisis. The meltdown has started and it has a long way still to run. No wonder Sarkozy’s hair has turned 98% grey or silver in photo’s appearing in this weekend’s Sunday Times story on DSK.