Is the UK financial system prepared for disorderly Brexit?

25/10/2018

With less than six months to go before the UK is due to leave the EU and no sign of a deal being made, many businesses are concerned about how finances will be impacted and if we’re headed for another financial crisis.

But, according to the Bank of England’s Financial Policy Committee (FPC), “the UK financial system is resilient to, and prepared for, the wide range of risks it could face.”

Earlier this month the FPC met to review the main risks to UK financial stability.

Following this meeting they published a statement highlighting how they’re making the financial system resilient to risks and prepared to avoid future disruption.

Whilst the statement showed positive feelings towards the resilience of our banking system and the action taken by the UK to make sure businesses and households won’t have their financial services disrupted during Brexit, other areas revealed concerns.

Here are some of the statement highlights:

Bank resilience

The FPC, which was set up after the 2008 financial crisis to assess the risks to UK financial stability, has been reviewing estimates of possible ‘worst case’ economic outcomes associated with Brexit, however unlikely they may be.

The Bank said it continued to judge that the UK banking system would be strong enough to serve households and businesses, even in the event of a disorderly, cliff-edge Brexit in which there was no agreement or implementation period.

Using the results of a 2017 stress test which encompassed a wide range of UK macroeconomic outcomes that could be associated with Brexit, it said:

• Brexit risks do not warrant additional capital buffers for banks
• The UK banking system now has the capacity to absorb Brexit risks as well as further misconduct costs and stresses that could arise from intensifying trade tensions and tightening of financing conditions for emerging markets
• Losses on a scale that would have wiped out the common equity capital base of the system in 2007 can now be readily absorbed by available capital

Brexit preparations

An implementation period would reduce the risks of disruption to the supply of financial services to UK and EU businesses during Brexit. But, should this not be agreed the FPC has been monitoring the potential dangers. 

It said that there has been considerable progress in the UK to address these risks.

However, the Bank warned that the EU’s lack of planning presents growing risks to financial stability, particularly with regards to derivative contracts and the transfer of personal data.

The Bank said: “In the limited time remaining, it is not possible for companies on their own to mitigate fully the risks of disruption to cross-border financial services. The need for authorities to complete mitigating actions is now pressing.”

Leveraged lending

The FPC also raised concerns over the rapid growth of risky lending to businesses.

The global leveraged loan market is larger than – and growing as quickly as – the US subprime mortgage market was in 2006 which triggered the 2008 financial crisis.

Leveraged loans, which are defined as loans to firms that already have debts worth more than four times their earnings, could pose a risk to financial stability.

Whilst the Committee recognised that there are important differences between the two markets it said it would assess the implications of rapid growth of leveraged lending for both non-banks and banks. 

Global debt

The FPC also warned that emerging market debt has risen in the past decade which makes those economies, and the world economy, riskier.

Referencing the tightening of US monetary policy which has contributed to the tightening of global financial conditions, as well as acute market pressures in Turkey and Argentina, the Bank said a more widespread change in risk appetite could expose broader vulnerabilities.

It also mentioned that whilst the imposition of trade barriers by the US and China does not itself pose a material risk to UK financial stability, deepening tensions could trigger a further and more severe tightening of global financial conditions. 

What do you think? Are you convinced that the UK financial system is prepared for a disorderly Brexit? Let us know in the comments below.