A no-deal Brexit would send shockwaves through the global financial system and is one of the main risks to economic stability, the International Monetary Fund has said.
Echoing concerns from the Bank of England, the Washington-based organisation said the potential for millions of financial contracts between City banks and their counterparts across rest of Europe to collapse in the event of the UK leaving the EU without a deal was a major worry.
The warning puts further pressure on the European Research Group (ERG) of Conservative MPs to justify a no-deal Brexit over a compromise negotiated by the prime minister that includes an agreement on cross-border financial contracts.
Theresa May is seeking a settlement that at the very least would provide the legal framework for planes to fly across the channel, medicines to be imported from the continent and trillions of pounds worth of cross-border financial contracts to be maintained.
A no-deal scenario has the potential to undermine legal contracts and disrupt trade with the result that the UK would suffer a post-Brext recession, the Treasury has argued. The IMF said its central forecast remained that by the end of the year Brussels and London would agree a path towards a deal on trade in goods and services.
But it warned in a report for its annual meeting, which is staged this year in the Indonesian resort of Bali, that the failure to make progress not only had implications for the UK and eurozone economies but could also drag down the global economy.
“A rise in political and policy uncertainty could adversely affect financial market confidence,” the IMF said in its financial stability report. “For example, growing anxiety about a breakdown in Brexit negotiations could give rise to contractual and operational uncertainties in the United Kingdom and elsewhere in Europe.”
It added: “In general, the likelihood and severity of financial stability risks will be reduced by a closer relationship between the United Kingdom and the EU during the transition period and beyond, but will be heightened in the event of a hard Brexit.”
The importance of London as a financial centre was emphasised by the Bank of England on Tuesday when it said that the EU’s lack of planning for Brexit had created growing risks for almost £70tn of complex financial contracts. London boasts more foreign banks than any other financial centre and ranks as one of the world’s three most important hubs for trading and asset management along with New York and Tokyo.
Threadneedle Street said Brussels had made only limited progress to protect the financial system and time was running out, with little more than six months before the UK is due to leave the EU.
EU firms have about £69tn of outstanding derivatives contracts that must be settled in London. It is estimated that as much as £41tn will mature after Britain exits the bloc in March 2019.
The Bank has also estimated that £55bn worth of insurance contracts sold by UK insurers across the EU could be disrupted should they lose their authorisation to service these contracts.
Such is the scale of the potential threat to the financial system that the IMF said central banks should stand ready to provide their own commercial banks with extra borrowing facilities. It also warned that London-based banks worried about the implications of a no-deal Brexit could send funds abroad, triggering a flight of capital and upending stock and bond markets.
“Central banks should be prepared to use available instruments as needed. On the external side, a disorderly exit could lead to capital outflows. Authorities should closely monitor such developments and be aware of the potential for sharp asset price moves,” it said in its report.
The ERG has argued that a no-deal Brexit may be a better option than one that kept Britain aligned with EU rules, but prevented the government signing trade deals with other countries, especially the US.
It has dismissed concerns that the EU would block cross-border financial transactions from being processed in London in the event of a no-deal Brexit, saying this would be an act of self-harm.
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