“A better conflicting Brexit banking story couldn’t have come along than one I’ve noted over the past few days.
“It started with a bit of somewhat misleading information from a consulting company that suggested EU banks operating in the City post-Brexit would need to raise a substantial amount of equity capital to continue operations. The equity requirement was based upon those EU banks converting their City businesses into full-fledged UK licensed, and appropriately capitalised, banks.
“But surely these banks already have that equity capital supporting their business?
“To say otherwise is to imply the banks are currently not sound institutions. The argument would be that the EU banks would have to specifically allocate and move capital (effectively ring-fence it) to their City business. Of course this would create vast inefficiencies, such as if a bank had reduced opportunity in the City and increased opportunity in the EU, the bank could not easily allocate or make use of its equity capital toward its changing risks. This would lead to EU banks effectively having more capital than might be economically efficient, lower profitability, etc.
“Regardless, the Bank of England has now reportedly said that it won’t require such separate capitalisation – hopefully, helping these EU banks to have a longer term City perspective and maintain their diverse international activities. However, that may not be the same for certain UK banks operating in the EU due to UK legislation and regulation.
“Here in the UK, the government’s Independent Commission on Banking recommends the concept of ring-fencing, largely, retail businesses from other banking businesses. The ring-fence requirements allowed the UK banks to have certain retail related (my definition) EU businesses to be part of their separately capitalised ring-fence banks. Such EU businesses of UK banks may now fall victim of both UK rules limiting non-UK activities in ring-fenced banks and, potentially, EU constraints on foreign banks (UK post Brexit), perhaps requiring the separate capitalisation of these businesses. Of course, if separate capitalisation is the case, the UK’s banks will suffer inefficiencies and profitability constraints. Does this matter and why should we care?
“Purely domestic banks, by definition, cannot escape ties to the domestic economy. The conundrum facing UK banks encourages their further international business withdrawal. Since the 2008-2009 financial downturn, international banks have substantially reduced their international activity – and mostly for good reasons – but perhaps the above contrast indicates a turn of view that international diversification is desirable albeit requiring much greater controls than historically applied?”