British banks' offshore banking activities 'the greatest threat to national solvency'

A new paper shows that British banks engaged in more offshore banking than any other financial centre.

Researchers examining the resilience of the world's financial centres after the global economic crisis conclude that the future stability of the UK is perhaps the most uncertain of all.

The paper concludes that in an era where attention has focused on the sustainability of public financial debts, it would appear there should be more concern about the potential amount of private foreign debt being held by British banks, which it describes as 'the greatest threat to the national solvency'.

The working paper says that while the international position of British banks clearly benefited from being outside of the Eurozone, their foreign currency balance sheets are cause for concern'.

They are described as 'extremely stretched' on the eve of the crisis in 2007, and the paper warns that the future stability of The City may be 'in the hands of unpredictable global forces'.

The research paper authored by Dr Daniel Haberley from the University of Sussex and Professor Dariusz Wójcik from the University of Oxford is to be presented at the world's biggest economic geography conference, hosted by the University's School of Geography and the Environment and the Smith School of Enterprise and the Environment.

They show that British banks by nationality grew to become the world's largest (by international assets) in 2012. The paper links this growth with British banks shifting their focus away from Europe during the global crisis towards what were seen as more robust economies – the US and to a lesser extent Japan – as funding sources.

While British banks appear to have finally begun to deleverage in 2013, the paper shows this only brought their cross-border assets down to 2007 levels by the end of 2014.

Dr Daniel Haberly says, "The national cost-benefit balance of this offshore banking strategy is increasingly questionable. There has been a shift in where the risk is felt, so rather than its effects being outside of Britain, bad debts would affect the state's balance sheets and, in the long run, the British taxpayer. Taxpayers would end up paying the cost of bad debts resulting from the offshore banking activities undertaken by British banks, whether the banks were publicly run or not."

Professor Dariusz Wójcik says,"The UK is the offshore lynchpin of the global banking network. It appears to be trapped between an unravelling European financial system and an uncontrollable global financial system, with greater risks as host state than in the past due to the deregulation of recent decades."

The paper tracks the historical context, explaining that the UK's fragility is, in part, due to the deregulation of the 1980s, the so-called 'Big Bang', wherein the Keynesian-era ring-fencing system was torn down altogether.

Even more significant were the Basel Accords, which created a new regulatory framework ensuring that host states supervise the liquidity of their national banks globally. This produced an international 'race-to-the-bottom', says the paper, which increasingly took a more permissive approach towards nationally headquartered banks, as opposed to attracting foreign banks backed by foreign governments.

By contrast, in the 1950s to 1970s, offshore banking centres, led by Britain, were mostly able to shift the financial risks generated by deregulation onto other economies, the authors note.

The most resilient models in offshore banking were found to be those with large sovereign forex reserves, such as Singapore and Hong Kong. Currency sovereignty appears to be the key factor for stability, concludes the paper.

It says, in theory, Eurozone offshore banking centres should have been in a strong position to weather the crisis as they have their own currency.

However, ironically, the own currency debts of Eurozone member banks are described as 'more destabilising' than the foreign currency debts of other countries' banks.

The study argues this is because of the refusal of the European Central Bank to unconditionally backstop the debts of its member states. This had the effect of 'disproportionately' impacting Eurozone offshore banking centres, which should have been 'easily avoidable', the paper says.