An often overlooked risk of Brexit is that it could cause another transatlantic banking crisis, perhaps worse than the one in 2008 to 2009. It would again emerge out of financial deregulation in the US and the UK, and Brexit could be the trigger. Aware of this risk, the EU27 (the European Union’s member states without the UK) must, in the Brexit negotiations, remain tough, and ensure that control over European financial stability stays in the EU.
At present, much of the European wholesale banking market – in which banks and industrial clients trade in derivatives, foreign-exchange and large loans – is located in London. Banks from the EU27 in London have over €1 trillion ($1.2 trillion) in assets there. That’s not much less than the large British international banks have in London. US and Japanese banks also have a strong position.
A European Systemic Risk Board (ESRB) was established in 2010 as a macro-prudential regulator to ensure stability in these markets. It can only publish non-binding recommendations and opinions. Iceland and Norway are observers at the ESRB, and after Brexit the UK will probably become the third observer country.
The EU banking system would, in effect, be regulated out of the UK.
A report by this ESRB found that the British bank HSBC was the only “systemically relevant” British bank with cross-border European activities. But Mark Carney, the Governor of the Bank of England who is also First Vice-Chair of the ESRB deliberately left out a dynamic analysis of the effect that Brexit could have on Europe's banking systems, thereby violating the mandate of the ESRB.
Financial activities in London have, from an EU perspective, a much greater dimension. Just think of London’s clearing houses. In derivative trading, about 90 percent of euro-denominated transactions in 2017 took place in London. After March 2019, the EU will lose oversight over these transactions. After Brexit, about 60 percent of the EU’s wholesale banking market will still be based in London. Some of this business will relocate from London to the mainland. From the perspective of stability, however, it would be advisable that substantially more than half of the EU market should be based within the EU27.
With so much European finance still in London after Brexit, the EU banking system would, in effect, be regulated out of the UK. But the UK, following Brexit, will have lower economic growth and thus a strong incentive for a new wave of banking deregulation. Britain would follow the US under Donald Trump, which already started deregulating in 2017. Thus, as a consequence of Brexit, the EU wholesale banking market would in effect be primarily regulated by the UK, which in turn is likely to cut rules.
The EU cannot surrender control over the stability of its own financial markets.
This would be a new, absurd and untenable situation for Europe. It could also lead to another financial crisis. This would damage the legitimacy of the euro zone and the concept of European integration as a whole.
There is no incentive for the British parliament or government to consider the interests of EU financial market stability. So the EU27 must negotiate with their own interests in mind. To date, neither the EU nor its member states, nor even the ECB, have tried to address the implications.
The EU27 should ensure the following: The relevant clearing houses, which engage in euro-denominated transactions, should be subjected to the supervision of the ECB. (In the same way, the UK would never accept a situation where a large share of pound-denominated financial markets are based and regulated by a body outside of the UK.)
Theresa May will obviously defend the position of the City of London as jobs and income are at stake. For its part, however, the EU cannot surrender control over the stability of its own financial markets.
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