Opinion

Brexit stress test

By Kim Schoenholtz and Stephen Cecchetti

Kim Schoenholtz

...unless the global financial system as a whole is well capitalised – which we doubt – the system remains only as strong as its weakest link.

The UK’s Brexit referendum is providing us with the first significant test of the new regulatory system. This column asks whether banks have sufficient capital and liquidity to withstand the ‘shock’. Unless the global financial system as a whole is well capitalised, it remains only as strong as its weakest link.  And while the UK authorities have done a reasonable job of strengthening their banks and financial system, a number of large European banks are seriously undercapitalised.  

The UK’s Brexit referendum is providing us with the first significant test of our sparkling new regulatory system. Everyone knew about the referendum months in advance, giving them plenty of time to prepare. Yet, we are left with some fundamental questions related to global financial stability. Do banks have sufficient capital and liquidity to withstand the ‘shock’? Will financial markets continue to serve their key functions?  Or, is the financial system only as strong as its weakest link? Will turmoil once again prompt liability holders to run, triggering asset fire sales and compelling central banks once again to do whatever it takes to keep avert a meltdown?

As the rating agencies might say, we are on ‘stress watch’ with a negative outlook.

Troubling signs

Market fluctuations in the immediate aftermath of the referendum were characterised by large currency swings and significant equity price declines, particularly in bank stocks. Aside from the banks, stock markets generally recovered. But, other troubling signs have emerged. In Britain, several open-ended property funds have suspended redemptions (Lazarus et al. 2016). It is doubtful that they could sell illiquid real estate holdings on short notice – except, perhaps, at fire sale prices. And in continental Europe, the strains are building on several large, systemic banks.


Read full article as published by VoxEU.

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Kim Schoenholtz is Professor of Management Practice in the Department of Economics and Director of the Center for Global Economy and Business.