Business and independence: financial services

Published: 19 December 2013
Author: Brad MacKay

Brad McKay reflects on the implications of Scottish independence for three major industries, the energy, oil, and gas industries, financial services, and defence. In the second of four part series, Brad explores what impact independence might have on the financial service industry. The series will resume after the new year.

In contrast to the energy, oil and gas sectors, for financial services the challenges are more complicated. The currency adopted by an independent Scotland is of importance to both customers and financial institutions themselves, and tax rates are critical for certain financial goods and services traded, be they insurance policies or pensions. But with the 2012 Scotland Act, certain tax rates are likely to change irrespective of the referendum. Regulatory frameworks in this industry, however, will be of crucial importance for financial services firms when calculating the possible impact of different referendum outcomes. In the white paper the Scottish government divides regulation into two parts. The first is regulating the behaviour of individual banks and protecting the consumer. The second area of regulation is macro-prudential regulation, which basically translates into managing systemic risk across the entire system. With around 90 per cent of their business outside of Scotland, regulation is an issue that plays very strongly in the business strategies of financial service firms. If Scotland were to be independent, financial service firms will need clarity on how regulation might work. The white paper rightly argues that an independent Scotland would have to set up its own regulator, and argues that regulation of financial services would be coordinated across the Sterling area. It implies that macro-prudential regulation – i.e. regulation of the entire system – could be maintained by the Bank of England Financial Policy Committee, while prudential regulation – e.g. regulation of individual bank behaviour – would, or could be managed by a shared prudential regulator across the Sterling area, or a Scottish regulator. Somewhat confusingly the white paper then suggests that there is an alternative, which is that regulation (which parts is unclear) could be undertaken by “the regulatory arm of a Scottish Monetary Institute working alongside the equivalent UK authority on a consistent and harmonised basis” (p. 114).

Regulatory frameworks in the financial services industry are critical for business strategy, they have direct implication for business decisions on where to locate economic activity, for instance, and the white paper is likely to have done little to address this particular uncertainty. Indeed, it may have exacerbated it. This is because it appears to set up a system of dual accountability, where financial services firms are being partly regulated across the Sterling area (assuming that Scotland adopts the Sterling following negotiations with the rest of the UK), and from Scotland. Such a system would not only be confusing, but could potentially lead to conflict and confrontation if one regulator disagreed with the other. The importance of regulation is of critical importance to financial institutions and will impact on business decisions of where to locate economic activity.  

The white paper also briefly touches on future bank bail-outs, an issue that has featured prominently in the independence campaigns. In many respects, the question of whether Scotland could have bailed-out large financial institutions is a distraction from debating far more pressing issues about the future competitiveness of different sectors in the Scottish and UK economies following the Scottish referendum on independence. The white paper points out that considerable effort, by the regulator in the UK, internationally and by the firms effected themselves, has been made to ensure that the same crises doesn’t repeat itself in the future, raising questions about how useful the question of bank-bailouts is in the debate (although crises, of course, have a tendency of originating from unexpected places – Nicholas Taleb has written about ‘black swans’ – high impact and low probability events that weren’t predicted).

For clarity, it is worth pointing out that when this issue is debated the distinction between giving distressed banks short-term liquidity help and bailing them out is conflated. During the recent crises, UK banks were, for instance, given short-term liquidity help from both the UK government and other governments where they were operating, such as the US government. The bail-out of UK banks, however, came from the UK government, to the sum of somewhere in the vicinity of £66 billion, or over half of Scotland’s GDP in 2010 (which stood at about £110 billion). The fundamental difference is that when a government gives short-term liquidity help, often at very high interest rates, they get their money bank. When governments bail-out a financial institution, they take an equity stake in them, and the ownership structure of the institution reflects this (the UK government still owns about 33% of Lloyds and 80% of RBS for instance) (p. 389).

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