Brexit: Is the financial services passport actually worth fighting for?

The 2008 crisis and the collapse of 'Icesave' made the dangers of passporting clear

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The financial services passport is not an accident waiting to happen; the accident already has happened. Those of us who oppose continuing with the ‘single passport’ for banks after Britain leaves the EU are not just warning of an abstract risk but are drawing on experience from the 2008 crisis.

In October 2008 Landsbanki, an Icelandic bank, collapsed. Because Iceland is a member of the European Economic Area, Landsbanki was able to operate in Britain using the financial services passport. It had no need to establish a UK subsidiary and subject itself to oversight by UK regulators.

Under EU rules the UK had limited role in supervising liquidity. Nevertheless the Financial Services Authority was aware of problems developing at the bank but it could do little beyond putting pressure on the Icelandic government to act.

Passporting allowed Landsbanki to offer online savings accounts to British customers. By the time of it failed, its superior interest rates had attracted 230,000 depositors to its Icesave brand. The bank held £4.6 billion in UK deposits at the time its collapse.

Icesave customers could take some comfort the deposit protection guarantee. Iceland guaranteed only the first €21,000 (about £17,000) of each depositor’s funds and Landsbanki had voluntarily joined the UK’s deposit insurance scheme which topped this sum up to £50,000.

Because passporting left regulation of Icesave to the Icelandic authorities, the responsibility for dealing with the crisis fell on the government of Iceland; but Iceland didn’t have the money to honour the deposit guarantee.

The British authorities stepped in. The bank’s UK assets were seized. Chancellor of the Exchequer, Alistair Darling insisted that all depositors should be repaid (to avoid further loss of confidence in the banking system) adding £800 million to the bill.

There then began a prolonged legal and diplomatic battle to reclaim the money had Britain paid to Icesave customers. In the end this was treated as a loan which Iceland finally repaid in January this year.

A second Icelandic bank failed at the same time. Unlike Landsbanki, Kaupthing operated through a UK subsidiary rather than passporting and the UK authorities were able to organise a smooth transfer of Kaupthing’s customers and their accounts to ING.

One of the key lessons from the Icesave affair was that passporting in its current form is not sustainable. In its analysis of the financial crisis the FSA proposed some options for reform. They included:

  • The restriction of branch passporting rights and the requirement that retail deposit gathering be conducted through fully capitalised subsidiaries supervised by the host country regulator.
  • Giving host countries’ supervisory powers to conduct a whole bank assessment and to refuse local branches the right to operate if not satisfied.

The House of Lords Economic Affairs Committee also made recommendations to reform passporting:

“The Government should work towards acceptance that branches of foreign multinational banks in the UK, whether European or not, should be subject to a greater degree of oversight by the British authorities and that local capital requirements should be introduced for these banks, under which repatriation would need those authorities’ permission”.

These reforms have never been implemented.

In the Icesave case, the willingness and the ability of the Icelandic government to discharge its responsibilities was a key factor. Iceland was a small country with big banks. Bank assets in 2008 were ten times the size of the country’s national income.

Today the scale of banking has fallen but there remain small countries with big banks. Luxembourg, for example, has a banking sector 15 times its national income.

Passporting is a topic frequently mentioned in discussion of Britain’s future relationship with the EU. To date the terms of the debate have been set around whether or not the EU will allow financial firms to retain the passport.

There is another equally important question: should we want to?

Once outside the EU the UK will have no influence to push for the reforms advanced by the House of Lords and the FSA. Experience of the Icelandic banks show that passporting carries risks to financial stability.

It would be better to avoid passporting and to require all overseas banks to establish UK subsidiaries with their own capital and subject to regulation by the UK authorities.

Jos Gallacher represents Labour International on the National Policy Forum of the Labour Party.

See also: Passporting peril: How can the UK make banking safer post-Brexit?

2 Responses to “Brexit: Is the financial services passport actually worth fighting for?”

  1. Dave Stewart

    All your points are valid however you do not mention any of the benefits to the UK economy which arise from passporting. We have a huge financial sector which is reliant on it’s unfettered access the single market and passporting is an important part of that.

    I’m not coming down on either side of this debate as I don’t the full facts but it seems any analysis ought to be looking at both the risks and benefits before coming to a conclusion.

  2. Jos Gallacher

    I have been looking for assessment of the benefits of passporting and I can find no analysis at all on the subject. It is frequently asserted that passporting benefits the City or the UK but no evidence to back up the claim is ever offered.

    In my earlier article (link above) I explained why banks support passporting to improve profitability, or rather give a higher RoE. However the same could be said for higher leverage ratios, but the direction of regulation since the global financial crisis is towards requiring banks to hold more capital.

    Society needs to limit the risks banks take; it can’t be left to the profit motive.

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