The West's political landscape is almost unrecognisable compared with what it was just a year ago, leaving banks in the US and Europe experiencing political risk from closer quarters than they are used to. Brian Caplen assesses the situation.

Western European banks never used to worry much about political risk in their home markets. That was considered a problem for international banks in faraway emerging markets or those European banks with operations in eastern Europe. But after the Brexit vote and Donald Trump's election win in the US, the main topic of conversation among senior bankers in London, Paris and Frankfurt is political risk. 

Over the next few weeks and months a whole series of elections plus the constitutional reform referendum in Italy on December 4 could lead to a populist, anti-EU government coming to power in a major European country. In Italy, the political uncertainty is accentuated by the weaknesses in the banking system and worries that bad politics could destabilise it further. 

For bankers, the additional concern is a lack of leadership to try and address the situation. While some have cited German chancellor Angela Merkel’s decision to run for a fourth term as the great hope for preserving liberalism, both politically and economically, a more realistic view is that Ms Merkel will now confirm the axiom that 'all political careers end in failure'.  

Instead of responding to the rise of populism with policies to extinguish it, the Merkel line – and that of other EU leaders – is to stick hard to your principles and fight your corner.

This is at odds with a pragmatic business approach whereby a successful outcome is about finding compromise solutions. In the EU context this might include softening the application of the bail-in rules to Italian banks to avert the problems of ordinary savers losing money. More critically it means ditching the mantra of the EU single market’s four freedoms in goods, capital, services (which is a myth anyway) and people, and coming up with some kind of temporary brake or slowdown on free migration. At the very least this could be done at the lower end of the wage spectrum, which is the cause of so much political discontent. That act alone would destroy the political aspirations of French and Dutch far-right leaders at a stroke.

But as long as ideology takes precedent over clear thinking, the risk of a populist government coming to power in France, Holland or Italy and destroying the EU must be seen as high. Under the current circumstances banks should prepare for the worst, including a major country leaving the eurozone and the market disruption that would involve.

Brian Caplen is the editor of The Banker.

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