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Fear and Lothian

29 May 2014 By George Hay

Friday Sept. 19, 8.00 a.m. Staff at Royal Bank of Scotland’s Princes Street branch in central Edinburgh arrive for work, a tad bleary eyed. Some only had a few hours of sleep after partying until the wee hours, celebrating Scots’ historic vote to secede from the United Kingdom the previous day. Barely any whisky remains in the city’s bars; but RBS employees are about to discover something even worse. With customers starting to withdraw their deposits, barely any money may soon remain in Scottish banks.

This nightmare scenario is far-fetched: properly handled, there is no reason why a Yes vote on Sept. 18 should trigger serious liquidity problems for Scottish banks. But with the vote less than four months away, stakeholders in the three main lenders headquartered north of the putative border – Royal Bank of Scotland, Bank of Scotland (now part of Lloyds Banking Group) and Clydesdale – need much more clarity on what would happen in the 18 months between a Yes vote and the date mooted for formal independence, March 24, 2016.

UK banking stability is based on two pillars. The government insures retail deposits up to 85,000 pounds, and the Bank of England acts as lender of last resort in an emergency. The key risk following a Yes vote is that depositors doubt an independent Scotland’s ability to shoulder the burden. Given that domestically domiciled bank assets constitute 12 times Scottish GDP, the concern would be understandable.

One big problem is that Scottish bank deposits aren’t all held by Scottish depositors, but by residents in the rest of the UK (rUK). RUK savings in Scottish banks constitute a full quarter of the UK banking sector’s 1.7 trillion pounds of household and corporate deposits, according to Deutsche Bank. If customers fear their deposits will get redenominated into a weaker Scottish currency, corporate treasurers in particular could withdraw their funds – unlike consumer savings, corporate and interbank deposits aren’t insured by the state.

With an 80 percent stake in RBS, the UK government has a strong incentive to ensure any transition is trouble-free. The easiest way for Bank of England Governor Mark Carney to make this happen would be a public declaration on Sept. 19 that it will act as lender of last resort to a newly independent Scottish banking sector. Ideally, he would make the pledge before the vote even happens.

But it would be a big surprise if Carney actually did so. Since the start of the year, rUK politicians have insisted an independent Scotland would not be allowed to use the BoE to backstop its banks’ liquidity: if they could, it would mean a so-called currency union that would allow Scots to keep using sterling. Such a concession before the vote would enable Scotland’s pro-independence First Minister Alex Salmond to tell voters that the bank problem had been solved – increasing his chances of winning.

It could also be hard for UK politicians to OK a currency union soon after Sept. 18. Rapidly agreeing one following months of denials would make defeated rUK politicians look two-faced. Even if they did agree, rUK would almost certainly demand unappealing quid pro quos which the newly independent Scottish government might take time to agree to – such as Scottish taxpayers guaranteeing central bank losses, or shouldering a bigger share of the UK public debt.

That’s why Carney, rUK Prime Minister David Cameron and Salmond should probably announce a different step on Sept. 19. RBS, Bank of Scotland and Clydesdale could instantly re-domicile to London, and rebrand their Scottish operations as subsidiaries of an rUK parent. This would be controversial: it would increase rUK’s already large financial sector relative to its now-smaller GDP; and independent Scotland’s balance of payments would suffer as it became an importer of financial services rather than an exporter. But it would better protect the banks’ credit ratings and funding costs – as well as better preserving stability.

The rUK campaign to rubbish an independent Scotland’s finances is already well under way, with a UK Treasury paper on May 28 being the latest example. Given that scaremongering could help achieve the best outcome for financial stability – a No vote – it is a necessary evil. But a loss of face from relinquishing Scotland would be nothing compared to what would happen if Cameron and co. lost control of financial stability while dithering over a currency union. They should be contingency planning as hard as they are electioneering.


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