No one doubts that London will remain Europe’s financial centre

It is nearly 20 years since the Bank of England was relieved of its responsibility for the “sponsorship of the City”.

When the central bank was handed its independence from political control in 1997, the government took the view that the Bank should focus solely on maintaining monetary and financial stability, leaving others to cheerlead for the UK’s financial services industry. Yet in recent weeks, the Bank has at times sounded again like an arm of the Treasury, if not a branch of the British Bankers’ Association.

In a series of interventions, Bank officials warned of risks to European financial stability from hard Brexit, arguing for transition periods to allow banks to adjust to any new settlement between the UK and the EU.

“The UK is effectively the investment banker for Europe”, Mark Carney, the Bank’s governor, said this month. “More than half the investment and debt is raised in
the UK by firms based in the UK, quite often to investors based in the UK. And these activities are crucial for firms in the European real economy . . . and it’s absolutely in the interests of the EU that there is continual access to those services.”

To hear the Bank warn of risks of a sudden stop in funding for Europe is music to the ears of London-based bankers, some of whom have made this a central plank of their Brexit lobbying efforts. It is also music to the ears of officials at the Treasury, which has been engaged in a battle with other Whitehall departments over the need for a transition period; indeed, Philip Hammond, the chancellor, cited financial stability concerns when he said this week that “thoughtful politicians” on both sides of the Channel recognised the need for a transition period. This narrative is also popular with Brexiters, who regard it as confirmation that the UK has significant leverage over the EU.

The problem is that this argument— “Fog in the Channel; Continent cut off”— doesn’t stand up to scrutiny. Certainly, it is hard to find any Europe-based banker or policymaker who recognises any serious risk to European financial stability from Brexit, so long as bank supervisors do their jobs properly. No one doubts that if the UK quits the EU single market — depriving London-based banks of financial passports that allow them to offer financial services across the EU — that this will create operational and regulatory challenges for many firms. However, these obstacles are hardly insurmountable.

True, some firms will need to establish an onshore EU-based subsidiary and relocate some senior management and customer-facing staff, but most banks engaged in European business already have EU-based legal entities. Nor will everyone who needs to move be relocated to one place. More likely, some staff who are currently based in London but spend half the week visiting clients in their home markets may have to base themselves in their domestic market and spend half the week in London.

Nor should the regulatory obstacles— notably the need for banks to gain regulatory approvals for the models they use to calculate capital requirements — be overstated. Since taking over responsibility for eurozone banking supervision last year, the European Central Bank has been obliged to rely on models previously approved by 19 different national regulators. “If we can accept models approved by the Bank of France and BaFin [the German regulator], we’re very unlikely to reject a model that has already been approved by the Bank of England,” one senior eurozone banking official said.

Of course, changes to business models will come with costs that any bank would prefer to avoid until the Brexit outcome is known. It is also true that these costs could push up the cost of finance for borrowers.

Similarly, any fragmentation of the European financial system could unwind some of the agglomeration benefits that arise from London’s status as Europe’s financial center. Some firms may even decide to quit certain activities altogether. However, these risks need to be set in the context of a banking industry in a constant state of regulatory-driven change for the past eight years. No one doubts that London will remain Europe’s financial center, even if the way that borrowers access those markets changes.

So why is the Bank talking up risks that at best seem marginal? One reason may be that it finds itself in an invidious position. If it really sees risks to financial stability, then it has an obligation as the UK’s bank supervisor to insist that firms activate their Brexit contingency plans in sufficient time to be ready for any outcome. However, any suggestion that it is actively pushing banks out of London would be politically explosive. It would also conflict with the Bank’s lesser-known, secondary objective to “support the government’s economic policy”. The government’s policy is to make a success of Brexit, which means preserving London’s role as Europe’s financial centre and the tax revenues that brings.

Yet the Bank’s approach to these conflicting objectives carries risks. The first is that in reinforcing the notion that “they need us more than we need them,” it risks contributing to a distorted sense of the UK’s leverage, with the risk that London overplays its hand. The second is that by focusing attention on the importance of a transition plan, the Bank may be diverting attention from the very real risk that the divorce negotiations collapse in a disorderly way.

A prudent regulator should be focused on ensuring that firms under its supervision are prepared for the worst-case scenario. That would minimise any risks to European financial stability — which is still the only objective that really matters.