The Bank of England is preparing for the absolute worst case Brexit scenario
LONDON – The Bank of England is preparing itself for the worst when it comes to Brexit. Mark Carney said on Tuesday that the central bank is putting contingencies in place for the possibility that Britain drops out of the European Union without any deal in just under two years time.
Speaking after the bank released its twice-annual Financial Stability Report, Carney told reporters that the bank is — sensibly enough — making plans for all possible Brexit scenarios "however unlikely" to ensure it is as prepared as it can be for the country's departure from the EU, and the impact it may have on financial stability.
Carney said that the bank is planning for two possibly disruptive sets of consequences to stability caused by Brexit. First, he said, the bank must protect against the direct impacts on financial services firms, while also being prepared for any macroeconomic shock to the UK caused by leaving the European Union.
"There is a range of possible outcomes for the UK’s future relationship with the EU, and a number of possible paths to that relationship," Carney told reporters.
"Consistent with its remit, the FPC is focused on scenarios that, however unlikely, could have the greatest impact on UK financial stability.
"This includes a scenario in which there is no agreement in place at the point which the UK leaves the EU. That’s the type of scenario where contingency planning and preparation will prove the most invaluable. Without such plans, financial stability could be affected directly — by the impact on the direct provision of financial services — and indirectly — through macroeconomic shocks."
A so-called cliff edge Brexit — the no deal scenario to which Carney alluded — is something that has been the subject of much debate since Prime Minister Theresa May famously said that "No deal is better than a bad deal" when it comes to leaving the EU.
Under May's argument, Britain would drop out of the EU, immediately reverting to unfavourable WTO trade terms, if the country's negotiators failed to get an agreement seen as having favourable terms for the UK. May has widely been criticised for this approach, with a report from the London School of Economics earlier in June saying that failure to strike a deal with the European Union on trade during Brexit talks will lower income per household by at least £1,890 a year.
To clear, the Bank of England is not making any predictions — publicly at least — about what sort of Brexit deal is likely, and it would be unwise to think that Carney was doing so today.
The bank is simply planning for the worst possible outcome in economic and financial stability terms, which is an eminently sensible thing to do.
Britain's central bank outlined some of the negative impacts of a no deal Brexit in the Financial Stability Report, noting the possible consequences for the City of London.
"There is no generally applicable institutional framework for cross-border provision of financial services outside the European Union," the report said, adding (emphasis ours):
"Globally, liberalisation of trade in services lags far behind liberalisation of trade in goods. So without a new bespoke agreement, UK firms could no longer provide services to EEA clients (and vice versa) in the same manner as they do today, or in some cases not at all. This creates two broad risks. First, services could be dislocated as clients and providers adjust. Second, the fragmentation of service provision could increase costs and risks."
Earlier, the Bank of England announced that it has increased the so-called counter cyclical capital buffer (CCB) from 0% to 0.5%, with the expectation that that buffer will be increased to 1% at the next stability report in November.
The buffer is effectively put in place to ensure that lenders do not get themselves into the same positions that they did during the financial crisis, protecting themselves from debt going bad and triggering another credit crunch.
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