Scots War Games Haunt U.K. Elite Bracing for ReferendumScott Hamilton and Svenja O’Donnell
As Scotland stares history in the face, London’s financial guardians are preparing for their worst-case scenario.
Less than a week before a referendum that could see Scotland ending its 307-year political bond with the United Kingdom, officials at the Bank of England and the Treasury are gaming out how they would shore up the financial system if that happens. With the result being announced ahead of a normal trading day in the U.K., among the chief risks facing officials in the first 24 hours after any “yes” vote: a flight of deposits, a run on the pound and a drying up of bank liquidity.
Panic “grows exponentially so the key thing is to not let it start in the first place,” said David Bell, professor of economics at the University of Stirling. “As soon as rumors start getting around, it seems to me that it’s very bad news.”
While polls currently suggest Scots will opt to stay with the U.K. by a narrow margin, the vote is so close that officials are girding themselves for the possibility of the biggest shock to the financial system since the collapse of Lehman Brothers Holdings Inc. in 2008. The pound has the potential to tumble 10 percent within a month, said 61 percent of the 31 respondents in a Bloomberg News survey conducted Sept. 5-11.
BOE Governor Mark Carney and Chancellor of the Exchequer George Osborne may need to act within hours, say former policy makers, economists, academics and government officials. That will then buy them enough time to start the 18-month negotiation process that would follow any Scottish secession.
“What Carney will be worried about initially is the potential flight of deposits,” said former deputy governor John Gieve, who was in charge of financial stability at the central bank during the run on Northern Rock Plc in 2007.
While Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc, Scotland’s two biggest lenders, have said they plan to move their legal base to England if the country votes for independence, investors may still fret about any turmoil created by the transition.
Carney has said assets in the Scottish-domiciled financial industry are about 10 times the country’s gross domestic product, totaling more than 1 trillion pounds ($1.62 trillion). With questions over Scotland’s currency plans and lender-of-last-resort arrangements, that’s generating uncertainty about the future of the country’s banking system.
The first results, from Comhairle nan Eilean Siar, or the Western Isles council, are due around 2 a.m. local time. The urban centers of Glasgow and Edinburgh, where about a quarter of the electorate lives, may not start reporting until 5 a.m.
If the final outcome is “yes,” a team of officials will be put together at the Treasury in the early hours of Sept. 19 to deal with the fallout, according to an official who spoke on condition of anonymity to discuss confidential internal matters.
Campaigning is intensifying after a YouGov Plc poll last weekend put the Yes vote ahead for the first time this year. A survey by the same company published Sept. 11 showed a reversal, with the “no” camp leading 52 percent to 48 percent. A poll by ICM released yesterday showed the “yes” vote on 49 percent and “no” on 51 percent after excluding undecided voters, making it effectively too close to call given the margin of error.
As the risk of Scotland severing its monetary, fiscal and political ties with the rest of the U.K. rises, London’s politicians have deliberately avoided using the word “contingency” in case it’s seen as preparing for defeat.
“The government has not been and will not do that type of planning,” Cameron’s spokesman, Jean-Christophe Gray, told reporters in London on Sept. 11.
Cameron, who didn’t watch the two television debates between the leaders of the “yes” and “no” campaigns because he was on vacation in Portugal and then southwest England, made an emotional plea to Scottish voters on Sept. 10 not to break up the U.K. He’s planning another trip to Scotland on Monday.
Nationalists, led by Scottish First Minister Alex Salmond, say both sides should prepare for a “yes” vote after signs of increased momentum toward the independence campaign.
The need to calm financial markets may be one of the key challenges facing politicians and the BOE. Unlike the government, Carney has said publicly he has contingency plans.
He told a Sept. 10 parliamentary hearing in London that his back-up preparations involve “considerable resources.” A BOE spokesman declined to give additional details.
“They relate to specific institutions and specific situations, and from considerable experience making plans public about specific institutions and specific situations can be counterproductive,” Carney told lawmakers.
One step the BOE could take in the initial hours is to reiterate it is still the lender of last resort to all U.K. banks, including Scottish ones, until any formal separation, according to Allan Monks, an economist at JPMorgan Chase & Co. in London.
Gieve, the former central banker, said officials will be talking to lenders to make sure enough banknotes are stocked in cash machines and extra resources will be in place to deal with a potential increase in demand from customers wanting to access their accounts through the Internet.
The memory of the run on Northern Rock in 2007, where a panic was fueled because depositors couldn’t access their money online, is seared into the minds of policy makers.
The central bank will also probably be coordinating with lenders to make sure they have sufficient eligible collateral ready to exchange with the BOE if they need to use its liquidity facilities, Gieve said.
In an extreme scenario, officials could implement temporary controls such as limiting the amount bank customers could withdraw each day, or closing lenders by imposing a special so-called bank holiday, said Bell at Stirling University. Authorities could also re-capitalize institutions, restructure their liabilities and help them raise funding -- though Gieve said he thought such steps would not be necessary.
“Everybody will want to do the best for Scotland whatever we decide, but at the end of the day, nobody’s going to put their own savings or their own mortgage at risk,” Alistair Carmichael, the Scottish secretary in the U.K. government, said in an interview in Edinburgh this week.
Britain’s leaders will have decisions to make in the run up to the vote and in the hours immediately after it.
Growing concern in government, which has so far refused to admit publicly it has contingency plans, was made apparent yesterday by Osborne’s decision to cancel his trip to the Sept. 20-21 Group of 20 meeting in Cairns, Australia. Had he traveled, he risked being uncontactable for hours in the air when the results were announced.
Asked yesterday about the plans officials had in place to avert a credit crunch in the event of a “Yes” vote, Osborne said his decision to not attend the G-20 was motivated by the “economic risks” surrounding the vote.
Carney will be in Cairns on Sept. 17 and leave the gathering early to get back to London in time for the referendum results, a spokesman for the BOE said separately.
The central government has plans in place should Scotland vote for independence and they’re just not formally written down, a government official said. The Scottish National Party, which runs the semi-autonomous government in Edinburgh, will convene its cabinet at St. Andrew’s House in the city once the result is known to figure out the next steps.
To head off investors shunning U.K. assets and unloading government bonds, the Treasury may reaffirm its commitment to service all Britain’s debt to prevent gilt yields soaring, said Maeve Johnston, an economist at Capital Economics Ltd. in London. Banks may also want the government to reiterate it guarantees U.K. retail deposits through the Financial Services Compensation Scheme.
JPMorgan said in a note to clients last week the bank would expect “immediate recognition of the result by the U.K. government in the form of a commitment to begin negotiations on the exact terms of separation.”
Officials may have to continue to monitor for signs of financial distress during the period of transition toward formal independence as the negotiations between the U.K. and Scottish governments ebb and flow, Bell said.
The Scottish government has named March 24, 2016, as its targeted date for declaring independence. Until that date, the Bank of England will remain a backstop to Scotland’s lenders.
“I can’t see how there would be necessarily a banking crisis per se given that Scotland would still be part of the U.K.” during the negotiations, Ronald MacDonald, a political economy professor at Glasgow University, said in an interview. “It’s after independence day really that the possibility of a banking crisis could arise.”
Sterling has already suffered its worst month in more than a year, falling 5.4 percent against the dollar from a five-year high in July and touching its lowest level in 10 months this week as momentum for the nationalists increased.
Away from financial markets, Cameron may also face a crisis in his own Conservative Party.
One Tory lawmaker, who asked not to be named because of the political sensitivity of the matter, said it was impossible to know how his colleagues would react to the shock of the breakup of their country after more than three centuries. While the Tories have struggled in Scotland in recent decades and have only one Westminster lawmaker there, the party brands itself as the patriots protecting the U.K.
There is already a section of rebels that dislikes their leader so much that they would take any excuse to try to remove him, the lawmaker said. The question is whether others would join them, he said.
Under Tory rules, a vote of confidence in the leader is triggered if 46 lawmakers write to Graham Brady, the chairman of the 1922 committee comprising the party’s rank-and-file members of parliament. By convention, Brady refuses to discuss how many such letters are currently outstanding in his safe.
Were he to get close to the threshold, he would first call lawmakers who had written some time ago to check their wishes. He could also alert Cameron’s office, to give him the opportunity to avoid a vote by quitting.
All will start to become clear in the small hours of Sept. 19 after residents of Scotland cast their ballots.
Scots vote in 32 council regions between 7 a.m. and 10 p.m. local time on Sept. 18, with counting beginning at the close. Each council will report their totals to a central hub at the Royal Highland Centre in Ingliston near Edinburgh Airport, before declaring them once authorized by the chief counting officer, Mary Pitcaithly.
Pitcaithly will announce the final result once all the regions have reported, though the outcome may become apparent before that.
In terms of the final announcement, Pitcaithly has said the timing of Scottish results in parliamentary elections in 2010 and 2011 may serve as a guide, when the declarations came at 6:30 a.m. and 7:30 a.m. respectively. In a BBC television interview broadcast on Sept. 9, Pitcaithly said she expected the final announcement “around breakfast time.”
Privately commissioned exit polls, such as by television news broadcasters, can be released once polls close, though no organization has indicated they are doing so. There will be no official exit poll.
People will start making a call on the result while each vote gets counted and many markets wake up to discover whether or not Scotland has chosen to become Europe’s newest sovereign state and negotiate a division of the U.K’s assets and liabilities.
“Contingency suggests you’re contemplating losing which isn’t the political line,” said Grant Lewis, an economist at Daiwa Capital Markets in London and a former Treasury official. “But there will be contingency plans in place, as you’d expect for any big event.”