A look at how the UK leaving the EU could profoundly change the country's financial sector. 

The referendum on the UK’s membership of the EU, due before the end of 2017, is forcing domestic banks to reckon with the prospect of a so-called ‘Brexit’. Such an outcome would have huge implications for British banking, which is one of the country’s most international industries.

Chart one

While many UK banks have a global presence, the country also plays host to a large number of foreign bank branches. In 2013, these made up 31% of total banking assets (see chart one). Of these branches, 43% were part of larger banking groups domiciled in other European Economic Area countries.

According to a Standard & Poor’s report from June 2015, the proportion of foreign branches is still about 30%. In the report, the agency also emphasised the role these branches play in providing funding to other institutions as they account for about one-third of interbank lending.  

Were the UK to leave the EU, these EU based branches would find themselves without passporting rights, which allow them to operate in the UK without having to establish a subsidiary. The current arrangement considerably eases the funding and compliance burdens for foreign banks in the UK, as they only have to comply with their own domestic requirements. In order to ensure that these EU banks could continue to operate with ease in the UK, the country would have to recognise European regulation as equivalent to its own.

The situation would be more complicated for non-EU banks with domiciled subsidiaries in the UK which they use to branch out to other member states. According to Standard & Poor’s, there are now 98 deposit-taking subsidiaries in the UK, coming from 56 different countries. If foreign lenders wanted to keep their access to the EU market, they would be forced to move their subsidiaries either onto the continent or to the Irish capital of Dublin.

The consequences of a split would be blunted if the UK managed to retain its membership in European Economic Area, since this would allow the country to keep access to the single market and importantly, would enable lenders to keep the passporting rights. But this would depend at least in part on goodwill of Brussels, which would have a serious incentive to discourage any such breaks in the future.

By some measures, the ties between UK banks to the rest of EU have loosened since the global financial crisis. Data from the Bank for International Settlements shows that counterparty claims of UK banks on their eurozone peers peaked in the first quarter of 2008 and have been falling ever since, reaching levels not seen since 2005 by the end of the second quarter of 2015. The claims of eurozone banks on UK lenders have also been on the wane since the crisis (see chart two).

However, from a different perspective, the UK still remains highly integrated with the single market, as the leader in providing myriad financial functions to the rest of the EU. For instance, it dominates wholesale financial services, providing 35% of wholesale finance within the EU, and is responsible for more cross-border bank lending than any other EU country.  

Chart two

                                                                                                                 

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