Cloud Of Uncertainty – Impact Of Brexit On The Banking Industry – Vikram From IMT Ghaziabad

“I’m not uncertain.” This frequently used statement on Wall Street is used by traders to indicate a sure shot profitable bet on a financial asset trade. They never say “I’m certain” as that would indicate zero risk – and there is no such thing as a riskless investment. Even instruments backed by governments can result in a loss, as seen by the negative yields on sovereign bonds.

After the results of the referendum in Britain to exit the European Union, there is a lot of uncertainty about the impact on banks, financial institutions, stock markets and indexes, bond yields and the overall global economy. No one seems to be quite prepared for the possible impact of Brexit. It is a seminal event and indicates a shift from the era of globalization and connected economies. Many countries are taking a strong stance on immigration and the free movement of labour. The political and economic future is uncertain especially for the BFSI sector.

London: World’s Financial Centre: The capital of Britain, London, was known as the financial hub of the world. It had even emerged as the most competitive financial centre in the world, ahead of New York, as per the Z/Yen Group ranking in 2015. London was also the major international financial centre in Europe. Availability of top intellectual human capital, world class infrastructure and optimal business environment made London the best and most influential financial centre in the world. Further, the convenient timezone along with the non-restrictive regulations and tax rules made it as an easy place to do business and as a result most of the top banks, financial institutions and asset management firms have central offices in London and employ thousands of people. London stood in the middle of the Asian-American trade.

After the results of Brexit, the shares of British banks tanked as the Brexit decision triggered a huge sell-off and was expected to impact future economic growth, increase banks’ non-performing assets (NPAs), increase funding and restricting costs, increased operational costs and decrease revenues.

Figure 1: Drop in share price after Brexit.

Some of the most significant implications for banks are as follows:

  • Impact on Human Capital and Operations: However with Brexit, Banks are now being forced to shift their operations and relocate employees outside the United Kingdom, with cities such as Paris, Luxembourg, Frankfurt, Dublin, looking to capitalize on the need for a new central financial hub in Europe facilitating the free movement of human capital and non-draconian financial regulations. Banks are working on their own Brexit strategy in order to reap the benefits of the EU Financial regulations, access to the single unified EU market and the “passporting rights” that allow them to serve clients across the entire EU bloc. According to the Boston Consulting Group, after Brexit, European banks will need to invest 40 billion euros to continue their UK operations. Banks will also need to evaluate their operational strategy with an extreme possibility being moving completely outside UK. Brexit will certainly lead to most banks scaling down their operations from within the UK. Further, hiring of new employees will be impacted as visa free recruitment will no longer be possible within the UK bank branches.

Figure 2: Number of bank employees likely to be relocated

  • Impact on Reporting Trades and Trade Clearing: The existing European Markets Infrastructure Regulation (EMIR) governing banks trading derivative instruments lays down rules related to trade clearance, trade reporting and risk management. Post Brexit, this will no longer be applicable. Banks will have to conform to new regulations that shall be established within UK. Also, since EMIR regulations will apply to EU based counterparties of a UK bank, Brexit will lead to increased regulatory and compliance pressures for banks. Banks will have to move beyond a single regulatory framework and this will lead to increased costs. Further there would be significant impact on ISDA agreements due to legal requirements.
  • Impact on Foreign Exchange Trading: London is the world’s largest and most dominant centre for trading of the Euro currency. In 2015, an attempt by the European Central Bank to debar clearing houses outside the Eurozone from engaging in euro trading failed because of the European Union court. This could change as a result of the UK losing its membership to the EU.

The Banking sector appears to be one of the most vulnerable and significantly impacted as a result of the Brexit vote. It presents a very uncertain environment for the future of the global banks. The effects will depend largely on the forthcoming negotiations that shall take place once Article 50 comes into place that allows a provision of two years to exit the EU.  The possible negative impacts as mentioned above can be controlled and reduced through successful negotiations that provide reasonable alternatives and legal amendments. The most ideal situation would be if the UK authorities develop parallel EU compliant frameworks and legal regulations that allow UK to remain the financial centre of the post-Brexit world.