Britain’s exit from the EU will have significant repercussions for politics, the economy and citizens across Europe. One of the biggest impacts will probably be felt in the financial industry and within that by investment banks as the region’s central hub, London, is likely to lose its full access to the single European market.
This could have substantial consequences for Britain: at 6.6% of national gross value added, it has the largest financial sector among major European countries, relative to the size of its economy. Financial services exports play a major role – and 44% of them go to the EU. Without the surplus it generates from providing investment banking services to EU customers, Britain’s current account deficit would be 40% higher.
Foreign banks, which account for nearly 50% of the UK banking system, dominate in London’s investment banking business. Most of their business is conducted through branches (total assets: EUR 3 tr) which currently use the single European passport to provide services to the entire EU. Following Brexit, particularly non-EU, but also UK banks are likely to lose this opportunity and will have to shift EU business to the continent. They will have to set up or build-out subsidiaries in the EU-27 with own capital, liquidity, corporate governance and fully-fledged operations. This could lead to an additional EUR 35-45 bn of capital being ‘ring-fenced’.
Investment banking accounts for nearly three-quarters of the UK’s financial services exports. Derivatives play a key role: together with New York, London is the dominant FX and interest rates trading hub and also clears the vast majority of euro-denominated interest rate swaps. If the EU/ECB were to require clearing to move to the continent, significant collateral would have to be shifted (up to GBP 14 bn) and fragmentation could drive additional collateral requirements (at least GBP 6-25 bn) due to loss of netting benefits.
For major investment banks, the challenges come not just from losing the single passport under Brexit but also from EU IPU proposals that require subsidiarisation via Intermediate Parent Undertakings for large non-EU banks. This represents a further leg of balkanisation with trapped capital, liquidity and resources – profitability will be under pressure and not all EU business models will be viable.
Extract from article in www.dbresearch.com – a Deutsche Bank Research publication