British Banks Can Weather a No-Deal Brexit

While UK banks may not be fully ready to conduct business in EU jurisdictions, from a liquidity and capital point of view they appear well-positioned to weather a no-deal Brexit scenario.

Despite Theresa May’s efforts to improve the EU withdrawal deal, it has been voted down by members of Parliament for a second time, increasing the chances that the UK will leave the Union on 29 March without a deal, or otherwise delay Brexit.

But, British banks have been preparing for a no-deal scenario for some time, and the capital buffers they have built since the financial crisis have put them in a good position to weather any disruption caused by a no-deal Brexit, Moody’s said in a report last month.

“UK banks have comfortable capital positions and robust liquidity buffers following years of intense regulatory pressure to increase both risk-weighted and leverage ratios and to strengthen their liquidity positions,” said Moody’s associate managing director Laurie Mayers. “Under a no-deal scenario, we expect the sector to remain profitable, albeit weakly so.”

HSBC, RBS and Barclays have collectively made provisions of around GBP 500 million, and bosses have lobbied the government for assistance to deal with some of the potential business casualties a no-deal Brexit may cause, Moody’s noted.

In November, BOE (Bank of England) stress tests indicated that Britain’s banks would be resilient in the event of a chaotic Brexit, though regulators including the FCA (Financial Conduct Authority) have warned of disruption in financial markets if there is a no-deal outcome.

While many banks may not be ready for a no-deal Brexit in terms of obtaining licences for their new EU businesses, staffing problems and contract renegotiations, from a liquidity and capital point of view, all indications are that they will be able to weather the storm.

The FT reported on Monday (11 March) that the BOE has instructed UK banks to triple their holdings of highly liquid assets in the run-up to Brexit, to ensure they will be able to withstand at least 100 days of severe stress — which could occur if banks stop lending to each other — rather than the 30 days that is normally required under the LCR (liquidity coverage ratio) framework.

Banks are reportedly also modelling their balance sheets on the assumption that they will not be able to swap pounds for dollars, in case they are shut out of currency exchange facilities, like during the 2008 global financial crisis.

The BOE plans to hold weekly auctions to ensure they are able to borrow in pounds and euros, and do not run out of cash in a no-deal scenario. It also has an arrangement with the US Fed to ensure continued access to dollars, and the ECB (European Central Bank) has activated a currency swap line to ensure access to euros, similar to the 2008 crisis.

The latest BOE estimates suggest that UK banks have over GBP 1 trillion of high-quality assets, more than quadruple the amount during the 2008 crisis, and more than 1.5 times the minimum needed to meet projected net cash outflows during a 30-day long market crash.

To withstand the BOE’s 100-day market stress scenario, banks don’t necessarily need to buy more assets, they just have to buy longer duration ones, according to Reuters BreakingViews.

BreakingViews also points out that banks’ reliance on short-term funding has decreased from 15 percent of total funding to just under 4 percent, and that in a worst-case scenario they could also immediately access another GBP 300 billion in emergency BOE liquidity with pledged assets.

In the worst “disorderly” Brexit scenario, banks’ aggregate common equity Tier 1 capital ratio would decrease by “a painful but manageable 4 percentage points to 10.7 percent”, it says.

All things considered, British banks appear to be in a relatively strong position to withstand the worst expectations of a no-deal Brexit, at least in terms of capital and liquidity.

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