Ending the Brexit transition period without an agreement on financial services risks “volatility and disruption”, the Bank of England has warned, adding that it may have to intervene to keep markets operating smoothly as it did at the height of the pandemic in March.
In its latest financial stability report, published on Friday, the BoE said that while most risks of disruption to cross-border services after December 31 had been mitigated, problems in providing cross-border financial services, particularly to EU-based clients, remained a real possibility.
Market volatility would be “reinforced” if traders of derivative contracts were not ready to shift from London to EU-recognised trading venues in the event that Brussels does not agree a change in policy, the report said.
Other types of disruption could affect EU-based customers of UK banks, if lenders are not allowed to continue providing services in some countries.
“Financial stability is not the same as market stability or the avoidance of any disruption to users of financial services,” the report stated. “Some market volatility and disruption to financial services, particularly to EU-based clients, could arise.”
BoE governor Andrew Bailey explained that the EU needed to make decisions on these services to prevent disruption next year, but said the UK central bank would intervene in markets if necessary.
“We cannot prevent disruption for EU clients caused by decisions elsewhere — regrettable though that is,” he said on Friday morning. “We will use our tools should we be in that situation — we have a substantial array of responses we can make and, in any situation like that, we will put them to work.”
When fear over the coronavirus pandemic caused turmoil in the trading of US debt instruments in March, the BoE was one of several central banks that took co-ordinated action to inject more liquidity into the market.
“What has the Bank of England got in its armoury? A lot,” Mr Bailey added, without giving details.
The central bank could rapidly increase the purchase of government bonds it buys under its quantitative easing programme as it did in March, when it calmed market volatility and capital flight with huge demand for sterling-denominated government assets. Trading in many financial markets can also be temporarily halted to ease extreme volatility.
On Thursday, UK prime minister Boris Johnson warned there was a “strong possibility” Britain would end the Brexit transition period with no EU trade deal. Financial services are being negotiated separately but a trade deal would make agreement on cross-border transactions more likely. However, Brussels is already preparing for a disruptive no-deal outcome, with contingency plans to keep planes flying and trucks moving when the transition period ends.
Markets are likely to react to the Brexit fears, analysts warned. “[The report] highlighted that banks are in a very healthy position as they head into what could be a very turbulent few months,” said Joshua Mahony, senior market analyst at trading platform IG. “However, with the government having staved off a wave of insolvencies and administrations through the pandemic, the next question is just how they can avoid any short term economic suffering that could come with a disorderly exit from the EU.”
Coronavirus economic disruption would not threaten UK banks’ stability, though, the BoE said in the report: UK banks still have high levels of capital, allowing them to absorb “very big losses” and keep lending — even if economic outcomes were “considerably worse than currently expected”.
Although the BoE warned of some “headwinds” to banks’ capital ratios in 2021, with capital levels currently 9 percentage points above minimum requirements, it concluded that lenders are able to support the economy.
In March, the central bank’s Financial Policy Committee lowered the capital “buffers” that UK lenders must maintain, so they would have more capacity to lend. In Friday’s report, it confirmed that it would keep these buffers at 0 per cent for at least another year, to keep loans flowing.
Lending support schemes during the Covid-19 pandemic have also proved effective, the BoE said. UK businesses have raised more than £77bn of net additional financing from banks and financial markets since coronavirus hit in March.
Most of the net bank lending over that period was via government-backed loan schemes. As result, in the year to October, net bank lending to UK small and medium-sized enterprises was more than 40 times higher than the 2016-19 average.
At the same time, UK businesses’ cumulative net equity issuance in that 12-month period was more than £18bn — compared with negative cumulative net issuance on average for the same period between 2016 and 2019.
The UK central bank usually publishes financial stability reports twice a year, but has produced three in 2020, with earlier versions in March and August, in response to the pandemic.
Additional reporting by Chris Giles
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