In what would be the first step toward a European banking union, the European Central Bank will become the main regulator for the biggest banks in the 17 nations that use the euro as their currency as soon as Jan. 1. Britain, a member of the European Union, chose not to join the euro zone when it was established in 1999, and has said it won’t take part in a banking union. That decision risks isolating London from its major trading partners and undermining its status as the world’s top money center. “If there is a European banking union and a notable missing member of that is the U.K., then that will likely hurt London as a major financial market,” says Jay Ralph, a management board member at Munich-based Allianz, Europe’s largest insurer.
London, the world’s biggest center for foreign exchange trading, cross-border bank lending, and interest rate derivatives, has 251 foreign banks and more international financial firms than any other banking hub, including New York or Frankfurt, according to TheCityUK, a bank lobbying group. The City and Canary Wharf, London’s financial districts, are home to three-quarters of the EU’s foreign exchange trading, including 42 percent of euro trades. Financial sector jobs have been disappearing in the wake of the credit crisis, with the Centre for Economics and Business Research saying employment will fall to a 20-year low of 237,000 in 2013.
The danger of a banking union that doesn’t include the U.K. is that Britain’s voice in setting the rule-making agenda will be weakened as the ECB gains new powers, bankers say. Trading in euros could shift to Frankfurt or Paris and be regulated by the central bank. A banking union that gives the ECB new supervisory powers will create an “inner core” of euro-region nations that sidelines the rest of Europe, including Britain, according to Thomas Huertas, a former U.K. representative on the European Banking Authority, which drafts financial rules for the EU.
The concern for U.K. banks is that “you end up with a policy weighting toward the euro-zone banks because they’re in aggregate bigger,” says Douglas Flint, chairman of London-based HSBC Holdings, Europe’s largest bank by market value. Spokesmen for British banks including Barclays, Royal Bank of Scotland Group, and Lloyds Banking Group declined to comment.
The EU has struggled to meet its yearend banking-union deadline as members negotiate provisions, including the scope of the ECB’s authority. The new regulatory regime—a response to Europe’s debt crisis—is aimed at reducing the mutual dependency of banks and their national governments. It is to be phased in for all 6,000 euro-area banks by 2014. In addition to common supervision, a banking union could mean that governments share the costs of winding down failed lenders.
The U.K. doesn’t want to have its banks come under ECB regulation because it doesn’t want to be responsible for paying for failed banks in Spain and elsewhere in the euro area, according to top U.K. government officials. Still, it’s wary of the potential impact of unified bank regulation in Europe. “The worst outcome would be the creation of an overpowerful banking bloc,” Deputy Prime Minister Nick Clegg said in a speech in October. “The rest of Europe needs to be crystal clear: If they integrate in a way that hurts the City, they potentially hurt Europe as a whole.”
The City remains the world’s most important money center because of its time zone, language, talent pool, and legal infrastructure, according to Z/Yen Group, a London-based research firm. New York and Hong Kong are ranked Nos. 2 and 3 by Z/Yen. “My personal view is, it won’t be dramatically bad for the U.K.,” says George Mathewson, who retired as chairman of Edinburgh-based RBS in 2006. “The U.K. has got some in-built advantages that are difficult to dislodge.”
If London is isolated as a result of closer banking ties in the rest of Europe, it might find itself under pressure to submit to ECB regulation after all. Foreign banks would consider shifting operations to within the euro zone, according to an executive with knowledge of lobbying by U.S. lenders who asked not to be identified because the effort is private. Ash Saluja, financial-services partner in London at law firm CMS Cameron McKenna, says global banks may choose to put themselves under full ECB supervision by moving their headquarters into the euro region—or by pressing the U.K. to surrender national regulation in favor of the single supervisory mechanism. It’s “very worrying for the City and the Bank of England,” he says. “The euro zone holds all the cards.”