Britain’s financial system is prepared for even a worst-case Brexit scenario with a hard exit from the EU and a consequent trade war, the Bank of England has announced.
All of the UK’s major banks survived this year’s so-called “stress tests” conducted by the Bank, designed to discover how the country’s financial plumbing would fare in the event of a hard Brexit.
The scenario, which goes beyond what most analysts would expect even from a worst-case Brexit, involves a UK recession with GDP falling by 4.7%, with interest rates rising to 4% and the unemployment rate going up to 9.2% and is the toughest “war game” test yet thrown at the UK banks.
None of the major banks failed, but two of them – Barclays and Lloyds – would have had to trigger emergency debt-to-equity conversions that would have affected investors.
The Bank’s financial policy committee said: “The core of the UK financial system, including banks, dealers and insurance companies, was resilient to, and prepared for, the wide range of UK economic and financial shocks that could be associated with a worst-case disorderly Brexit.”
It pointed out that even after the impact of its stress tests, major UK banks’ capital ratios would still be more than twice as high as they were after the 2008 financial crisis.
The Bank separately announced that UK banks would have to increase the amount of capital they set aside for future emergencies – a kind of buffer of equity on their balance sheet – by an extra percentage point.
In its Financial Stability Report, released alongside the result of its stress tests, the Bank said that “against a backdrop of Brexit-related uncertainty, growth has slowed and international investor demand for assets, notably commercial real estate, has fallen.”
The Bank also proposed a major crackdown on investment funds that make long term investments but promise to allow customers to withdraw their money at short notice.
In an intervention following the crisis associated with star investor Neil Woodford, the Bank suggested that investors may have to receive a discount to their investment if they want to withdraw it at very short notice. The proposal, to be submitted to a Treasury review on so-called open-ended funds, would amount to a major change in the regulations on these investment funds.
The Bank said the current system, whereby investment funds could put their money into long-term assets they cannot sell overnight yet could simultaneously promise investors they can exit the fund at a day’s notice could give rise to a “run dynamic”.