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Scottish banks and their liabilities

Chapter summary

  • In the aftermath of the credit crisis, Britain has coped relatively well compared with most EU members. However, six years after the crisis the UK Government still has a support liability of £835bn that the banks have not yet repaid. At least 40% of that liability is owed by RBS and the Scottish part of Lloyds (HBOS). In a separated Scotland a population of 5.3 million generating only £129bn of GDP would have to support £334bn of bank liabilities – far too much for a new Scottish administration to support.
  • Scotland’s banking assets (loans), at 12 times GDP, dwarf those of Iceland and Ireland. Should Scotland separate and lose the protection of the Bank of England, Scottish banks would be faced with the stark choice of either relocating the vast majority of their assets and their legal jurisdiction and headquarters to London, or shrinking their balance sheets precipitously.
  • If Scotland had been independent, the financial crisis of 2008 would have been a national calamity no less severe than the Darien venture that led to the Union in the first place.
  • In 2008 Iceland’s banking assets were 880% of GDP, or two-thirds those of Scotland relative to GDP. Iceland’s monetary system collapsed as credit dried up. Ireland’s system survived, but only at the price of enforced EU restructuring, a 40%+ fall in house prices, severe wage deflation especially in the public sector, highly elevated unemployment and national finances that moved from surplus to precipitous deficit almost overnight.
    The Scottish national balance sheet is simply not significant enough, and never could be with only 5.3 million people, to support the current activities of the Scottish financial sector.

Scottish banks’ liabilities are at least 40% of UK banks’ liabilities

Credit has been much harder to get in the past six years. After the traumatic events of late 2008, it has dawned on consumers and governments that credit is precious and scarce. Too much of it becomes a mill stone, too little and the economy grinds to a halt. What is certain, though, is that the period of easy, apparently risk-free credit is over. In the aftermath of the credit crisis, Britain has coped relatively well compared with most other EU members. However, six years after the crisis the UK Government, according to the Office for National Statistics, still has a support liability of £835bn that the UK banking sector has not yet been able to repay. If we conservatively assume that 40% of that liability is accounted for by RBS and the Scottish part of Lloyds (HBOS), in a separated Scotland a population of 5.3 million generating only £129bn of GDP would have to support £334bn of bank liabilities – a sum far too great for a new Scottish administration to support.

The chart overleaf looks at the current size of the banking sector of selected major nations relative to GDP. It is abundantly clear that Scotland could not support a banking sector of that size as a separate country without the Bank of England or some similar body as lender of last resort. Should Scotland separate and lose the protection of the Bank of England, Scottish banks would be faced with the stark choice of either relocating the vast majority of their assets and their legal jurisdiction and headquarters to London or shrinking their balance sheets precipitously. Neither can be said to be a palatable choice from the perspective of the Scottish electorate or taxpayer, especially as finance is such an important constituent of growth and tax revenue for the Scottish economy.

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It is no exaggeration to say that if Scotland had been independent, the financial crisis of 2008 would have been a national calamity no less severe than that which followed the Darien venture. Ironically, it was the failure of the Darien Scheme that led to the Union in the first place. Alone, with its banking sector dwarfing that of Ireland and Iceland at 1220% of GDP, Scotland would have been insolvent. Global markets simply would not have tolerated in Scotland the refinancing programme that the UK Government was able to secure. It is simply not feasible that the Scottish national balance sheet could prudentially support such a large exposure.

To put this difficulty in context, in 2008 Iceland’s banking assets were 880% in 2008, or 50% less than those of Scotland relative to GDP. Iceland’s monetary system collapsed as credit dried up.

Ireland’s system survived, but only at the price of enforced EU restructuring, a 40%+ fall in house prices, severe wage deflation especially in the public sector, highly elevated unemployment and national finances that moved from surplus to precipitous deficit almost overnight.

Like it, or not, the Scottish national balance sheet is simply not significant enough, and never could be with only 5.3 million people, to support the current activities of the Scottish financial sector.

To emphasise the importance of this point further, the chart below shows the stock market’s market capitalisation of banks by nation just before the crisis. On the basis of its banks’ market capitalisation, a separated Scotland in 2008 would have been in the basket-case basket with Iceland, Cyprus, Greece and Ireland. Those who seek separation simply have not thought through, still less addressed, the consequences of their proposed actions.

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A recent UBS report looking at the implications of separation demonstrated the risk of capital flight, especially during the transition. The UK is one large internal market protected by the lender of last resort, the Bank of England, backed by the UK Treasury. Scotland could not offer such protection. Savers would move their assets to wherever the risk seemed lower.

Would Scottish corporations and households prefer the prudential support of the Bank of England, that was proven to offer effective and successful support at the time of need in 2008, or would they prefer the support of a new Scottish Central bank backed by the Scottish Government? The former has the balance sheet and the credibility to act, the latter would not. Many, Scottish or not, would choose the Bank of England’s security blanket.

Capital flight could severely undermine Scotland’s economic health and tax base. UBS call this “the Montreal effect” after the flight of capital when Quebec voted on independence from Canada. The biggest winner then was Toronto as nervous Quebec-based corporates got out of Montreal. Quebec has never fully recovered.

on September 16 | by

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