As though the slowdown global economy and the migrant crisis were not challenging enough, the current ‘elephant in the room’ is the potential impact of Brexit. This is now being recognised with UK voters having been bombarded with Brexit warnings in recent weeks.
Most notably, the Bank of England (BoE) said last week in its quarterly inflation report that the economy could slow sharply and possibly even enter a brief technical recession should the country vote for Brexit. Governor Carney also warned that there were limits to what the BoE could do about it. In its starkest warning so far about the impact of an “Out” vote in the June 23 referendum, the BoE said that sterling could fall sharply and unemployment would probably rise. This may also result in a material slowdown in growth and a notable rise in inflation which would create a challenging trade-off for the BoE in respect of interest rates. Although the BoE expects an “In” vote, it has still trimmed its growth forecast for this year to 2.0% from February’s estimate of 2.2% due to jitters about the referendum already weighing heavily on the economy. Governor Carney also cautioned that there were limits as to what the BoE could do in response to an “Out” vote as monetary policy cannot immediately offset all the effects of a shock. However opinion polls suggest UK voters have been relatively resistant so far to warnings about the economic costs of Brexit, with voting intentions in many polls roughly evenly split.
Christine Lagarde, Head of the International Monetary Fund (IMF) has also waded into the Brexit debate by declaring that there were no economic positives to the UK leaving the European Union (EU) and that the impact would range from “pretty bad to very, very bad”. Her blunt warning came as the IMF said the country risks falling into a spiral of weaker economic growth, lower house prices and diminished foreign investment if voters opt to leave the European Union after the referendum next month. The IMF, in an annual report on the UK economy, said an exit vote would “precipitate a protracted period of heightened uncertainty, leading to financial market volatility and a hit to output.”
Moody’s has cautioned that the June 23 referendum on the UK’s membership of the European Union (EU) is likely to create some additional risks for both UK banks and other banks with large UK exposures. The severity of these risks will depend on the reaction of investors which may not be rational (as evidenced by the reaction to the recent Deutsche Bank Q4-2015 losses). Prior to the vote, Moody’s believes that the impact on banks should be limited to a short-term slowdown in business activity and potential wholesale margin pressure as investors may require an additional risk premium to hold debt instruments of UK banks. These effects should rapidly reverse in the event of a vote to remain in the EU.
Moody’s also cautions that a vote to leave could have more widespread consequences for both UK banks and other banks with large UK exposures. Moody’s believes that the 2-year period between the vote and actually leaving the EU would likely result in prolonged volatility given that the new relationship between the UK, the EU and other trading partners would take time to evolve.
A Brexit decision is likely to modestly depress the country’s GDP growth, which might lead the independent rating agencies to downgrade the UK sovereign rating and/or assign a negative outlook. These factors may further increase wholesale funding costs for UK banks resulting in a reduction in lending volumes and the squeezing of interest margins. This would in turn reduce capital generation and force banks to consider further cost-saving measures. This may force the Bank of England to consider (as a last resort) the introduction of negative interest rates on reserves to encourage lending and to seek other ways to encourage banks to lend
Many analysts believe that were Brexit to occur then it would be in the mutual interest of all parties to generate a period of calm and to work quickly together to put appropriate agreements in place. This view is underpinned by recent rating actions with Fitch having upgraded ABN AMRO Bank N.V. and ING Bank N.V. while Moody’s has upgraded Santander UK plc to reflect their stronger balance sheets (resulting from positive action taken by management to increase capital risk buffers) and healthier operating profits at 2015 year-end.
However, the reflective period for financial markets – as they come to terms with the fact that there is no ‘silver bullet’ to resolve the relentless slowdown in the global economy – appears to have been short-lived as concerns have resurfaced in the last few weeks as to how the major banks intend to strengthen their balance sheets between now and January 2019 to meet the more onerous regulatory requirements, against a backdrop of disappointing first quarter financial performance figures. This is reflected in adverse market price movements in early May which has reversed recent gains and resulted in the ITRAXX Europe Senior Financials 5-year CDS Index being around 30% more expensive year-to-date (up by 8.4% over the month) while the FTSE 350 European Bank Index of shares has fallen by about 20% year to date (down by 2.8% over the month).
The Competition & Markets Authority (CMA) may force the big four lender banks to push cheaper deals from rivals to assist customers to find cheaper overdrafts and loans as part of a crackdown on the big four lenders. It is expected that the watchdog will recommend that banks fund a price-comparison service. The recommendation are expected to form part of the latest findings of the investigation into the dominance of the big four — Barclays, HSBC, Lloyds and Royal Bank of Scotland. The plan would allow customers to create a report from their online accounts to give them a clear idea of whether they could find a cheaper overdraft or loan. The scheme could cost as much as £100m to set up. Small lenders are skeptical that the price-comparison site would help to improve competition as they fear that the big names would win out when interest rates were laid bare as the larger banks will be able to offer cheaper loans because their cost of funding is usually lower. Most challenger banks would prefer the authority to order fees on accounts that are currently free if in credit.
|5-YEAR CDS SPREADS AND SHARE PRICES|
|Date:||16th May 2016|
|5-Year CDS Spreads (bps)||Equity Share Prices (LCL)|
|Parent: Aldermore Group plc|
|Aldermore Bank plc||n/a||n/a||n/a||1.87||1.95||-4.1%|
|Allied Irish Banks||65||64||+1.6%||7.60||9.01||-15.6%|
|Parent: Arbuthnot Banking Group plc|
|Arbuthnot Latham & Co.||n/a||n/a||n/a||14.61||14.59||+0.1%|
|Aust and NZ Banking Group Ltd||107||118||-9.3%||24.11||23.85||+1.1%|
|Banco Bilbao Vizcaya Argentaria S.A.||127||121||+5.0%||5.51||5.93||-7.1%|
|Parent: Barclays plc|
|Barclays Bank plc||125||125||0.0%||1.65||1.67||-1.2%|
|BNP Paribas SA||80||78||+2.6%||44.02||45.16||-2.5%|
|Parent: Close Brothers Group plc|
|Close Brothers Limited||n/a||n/a||n/a||11.76||12.50||-5.9%|
|Credit Agricole SA||80||78||+2.6%||8.65||9.71||-10.9%|
|Parent: Credit Suisse Group AG|
|Credit Suisse AG||133||138||-3.6%||19.90||17.19||+15.8%|
|Deutsche Bank AG||176||176||0.0%||14.68||15.35||-4.4%|
|Parent: HSBC Holdings plc|
|HSBC Bank plc||101||98||+3.1%||4.30||4.51||-4.7%|
|Parent: ING Groep N.V.|
|ING Bank N.V.||72||64||+12.5%||10.43||11.07||-5.8%|
|Intesa Sanpaolo S.p.A.||127||119||+6.7%||2.22||2.45||-9.4%|
|Parent: Investec plc|
|Investec Bank plc||n/a||n/a||n/a||4.82||5.19||-7.1%|
|Parent: Lloyds Banking Group plc|
|Lloyds Bank plc||103||102||+1.0%||0.66||0.68||-2.9%|
|Metro Bank plc||n/a||n/a||n/a||21.00||20.48||+2.5%|
|Nationwide Building Society||76||81||-6.2%||n/a||n/a||n/a|
|Nordea Bank AB||65||75||-13.3%||76||78||-2.6%|
|Parent: RBS Group plc|
|Royal Bank of Scotland plc||134||124||+8.1%||2.11||2.35||-10.2%|
|Ult. Parent: Banco Santander S.A.|
|Santander UK plc||76||79||-3.8%||4.06||4.06||0.0%|
|Shawbrook Group plc|
|Shawbrook Bank Limited||n/a||n/a||n/a||2.56||2.80||-8.6%|
|Parent: Standard Chartered plc|
|Standard Chartered Bank||144||141||+2.1%||5.07||5.21||-2.7%|
|Svenska Handelsbanken AB||63||61||+3.3%||101||103||-1.9%|
|FTSE 350 BANK INDEX||n/a||n/a||n/a||3140||3231||-2.8%|
|SNR FIN ITRAX CDS 5-YEARS||97||89||+8.4%||n/a||n/a||n/a|