Bank of England warns of ‘material risks’ from Brexit

The Bank of England warned that regulatory authorities and politicians in both the UK and the European Union are not doing enough to prevent the "material risks" of disruption presented by Brexit that are hanging over vast numbers of financial contracts such as derivatives contracts and insurance policies, even if a transitional arrangement is agreed.

The warning from the BoE on Friday comes a week before a key European Council meeting where a transitional deal will be at the top of the agenda. David Davis, the UK minister leading the Brexit negotiations, said this week that he could "live with" with an implementation period of 21 months, slightly shorter than the two years the government said it would seek.

"Since November, in the United Kingdom, progress has been made towards mitigating risks of disruption to the availability of financial services. Nonetheless, material risks remain, particularly in areas where actions would be needed by both the UK and EU authorities," said the BoE's Financial Policy Committee, which tries to spot and mitigate risks to the UK's financial system.

It is particularly concerned over the £26 trillion (€29 trillion) of notional outstanding derivative contracts entered into by parties in both the UK and the EU, and how they might be serviced after Brexit. While the UK has said it will legislate if necessary to allow EU counterparties to service contracts with UK parties, no reciprocal announcement has been made by EU authorities.

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Stress tests

The FPC also laid out how it would conduct this year’s stress tests on the balance sheets of the seven largest UK lenders. It will keep the same scenarios as last year - a fall in house prices of 33 per cent, interest rates of 4 per cent, and a fall in UK gross domestic product of 4.7 per cent - because of an introduction of new accounting standards. The central bank wants to see the effect these standards, called IFRS9, will have.

IFRS9 forces banks to provision earlier for losses. It is an attempt to stop the problems seen in the financial crisis of banks being unable to make provisions for losses until they occurred, even if they could see them looming. The BoE expects that the implementation of the standard in the stress test will mean that banks’ capital ratios will fall faster and more sharply before recovering over time.

The FPC also delivered its assessment of risks posed to the system from crypto-assets. It judged that for now, they do not pose a financial stability risk but the committee said it would keep this tightly under review, including monitoring how closely banks and the "core" of the financial system are exposed. Earlier this month, the BoE's governor, Mark Carney, called time on the lax regulation that digital currencies and their ecosystem have enjoyed.

Overall, the FPC reported that apart from Brexit, the UK’s financial stability outlook remains “standard”. Global risks remain “material”, and of particular concern were risks stemming from debt markets.

– Copyright The Financial Times Limited 2018