Deep Impact: How will a Brexit Affect UK Banks?

A full year has passed since the June 23 Brexit referendum. Britons voted by a margin of 52% to 48% to break from the European Union. The Brexiteers may not have known it at the time, but the long-term consequences of a Brexit have far-reaching implications for UK banks. For starters, banks in Britain are currently operating with full access to European markets.

Those passporting rights will be affected in the absence of a negotiated settlement post-Brexit. On Monday, 20 March 2017, Prime Minister Theresa May invoked Article 50 of the Lisbon Treaty. That initiated the 2-year extrication process from the European Union.  Barring the consensus of all 27 remaining EU countries, the UK will not be allowed to extend that deadline and risks a ‘disruptive divorce’ in the absence of an agreement.

Imports and Exports Affected by Brexit Decision

The initial reaction of the Brexit decision was catastrophic for the GBP. It plummeted from 1.48 to the USD as low as 1.21, before stabilizing in a range between 1.25 and 1.28. The impact of a weaker GBP on the FTSE 100 index was equally profound. A weak sterling has the effect of boosting the foreign-based revenues of companies listed on the FTSE 100 index. As such, the UK all-share index rallied over 7,000, and has consistently remained in record territory.

Currently, the FTSE 100 index is trading at 7,424.13. Over the course of 1 year, the FTSE 100 index is up 17.13%, with a 52-week trading range of 5,788.74 on the low end and 7,598.99 on the high end. There are benefits and pitfalls to a weak GBP, with imports now costing more, and higher export-driven growth contributing to the GDP. However, the biggest concern with a Brexit is the impact on the U.K.’s financial sector. Various frameworks and trade ideas have been floated, but none has been finalized as yet.

For the most part, the UK economy has been able to withstand the shock of a Brexit decision, and the ongoing negotiations that have resulted. There is concern that inflation is rising too quickly (last measured at 2.9%), while real wages are struggling to rise. This has the effect of reducing the average household’s contribution to GDP, and will result in a contraction in coming quarters.

Politically, the position of Prime Minister Theresa May and the Tories has been hampered by a lacklustre showing in the June 8 election. Now, Prime Minister May is negotiating from a position of weakness. Recent reports suggest that Jeremy Corbyn has widespread popularity among the British electorate, although he has not been tasked with forming a new government.

Declining GDP Growth in the United Kingdom

UK banks are in for a rough ride in coming months. For starters, there is no consensus about how banks will negotiate deals with European countries. Without a blueprint, there is a great degree of uncertainty about the status of the City of London as Europe’s financial epicentre. Recall that the GBP rallied when Prime Minister May called early elections, but soon faltered when the results came in. On June 23, 2016, the GBP was approximately $0.21 stronger against the dollar.

The rapid decline in the GBP has caused it to lose approximately 15% of its value within a year. While UK exporters enjoy the benefits of a weaker sterling, the rising cost of imports is eating into the disposable incomes of Britons. Therefore, we are seeing a contraction in economic activity. By the end of Q4 2016, foreign investment in the UK plunged by 0.9%, and by 2019, the BOE (Bank of England) anticipates a 25% decline in business investment. What is striking is the performance of the UK economy by the end of Q4 2016, with gains of 0.7% recorded.

UK Remains Attractive Destination for Banks and Financial Institutions

At the start of 2017, the chief of the LSE cautioned about the impact of a Brexit on the City of London. In his opinion, up to a quarter million jobs could be lost without a clear plan after the Brexit. Multiple banks currently based in London have announced plans to close up operations, or relocate staff and business activity elsewhere in Europe. These include Goldman Sachs, HSBC, Barclays, UBS, Morgan Stanley and others.

 

Even non-bank entities which provide financial services such as Transferwise will be moving headquarters to Europe. These companies are doing this to protect themselves from the ravages of a Brexit. On Main Street, Britons are concerned that credit lines may dry up with a mass exodus of banks and financial institutions. However, the consensus remains that the UK will always be an attractive destination for banks and financial institutions given the regulatory framework and the tax-friendly nature of the UK.

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