The Bank of England has said risks to the UK financial stability remain elevated and warned that a disorderly Brexit would have damaging implications for the banking system and the economy.
In a twice-yearly assessment, the central bank said officials are assessing the potential fallout from the UK's exit from the European Union, with talks due to start next year.
With so much of the bloc’s financial activity centred in London, anything that forces institutions to change operations or services is a potential hazard to both the UK and the EU.
“If any such adjustments take place in a short time frame, there could be greater risk of disruption to services provided to the European real economy, which could spill back to the UK economy through trade and financial linkages,” the central bank said in its Financial Stability Report on Wednesday.
British prime minister Theresa May plans to formally start the exit process by March, triggering at least two years of talks.
The bank's emphasis on the risks around a short schedule come days after reports that governor Mark Carney favours an extended "transition" period to help firms adjust to whatever new trading relationship is agreed.
In addition to an interruption to services, the central bank noted a risk of a further weakening in investment banks’ profitability and more complex legal structures, which would make oversight more difficult.
The Bank of England will probe bank profitability in next year’s stress test of the system.
Stress tests
The report was published alongside the latest financial health check. While in aggregate the tests showed the banking system is well capitalised, Royal Bank of Scotland Group failed to clear some hurdles and had to submit a new capital plan.
On overall stability, the report echoed risks from previous reviews, including the current account deficit – almost 6 per cent of gross domestic product – high household debt, commercial real estate, market liquidity and the global environment.
The Bank of England said there’s been no material change to the UK’s ability to finance the current account, but warned that a sharp adjustment “could test financial stability”.
As this would be associated with a further drop in the pound, it would worsen the trade-off between growth and inflation, creating a further dilemma for Carney and fellow policymakers over how to set interest rates.
Sterling has weakened since the June EU vote, and the central bank noted the currency’s October flash crash.
While this proved to be short-lived, the bank said such events “underscore the concern that liquidity in some markets may have become more fragile.”
Global risks
The bank also drew attention to global risks, saying this source of vulnerability has increased since its last review in July.
Expectations of a US fiscal boost and risks of reduced global trade since Donald Trump’s victory in the presidential election reinforced weak spots in indebted emerging-market economies.
Uncertainty is further heightened because of the Italian referendum this week and elections in countries including France and Germany next year, it added.
“The outlook for UK financial stability remains challenging,” the bank said. “The economy has entered a period of adjustment following the EU referendum. The likelihood that some UK-specific risks to financial stability could materialise remains elevated.”
– (Bloomberg)
