Philip R Lane: The Brexit discontinuity
Speech by Mr Philip R Lane, Governor of the Central Bank of Ireland, to the 2019 European
Financial Forum, Dublin, 13 February 2019.
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Introduction
I am pleased to address the 2019 edition of the European Financial Forum. Currently, both policy
officials and private-sector participants in the global financial system are confronted with a
combination of cyclical and structural concerns. At the cyclical level, the recent revision in global
growth projections and the downside shift in the risk distribution require a careful assessment of
the likely duration of adverse shocks and the potential offsetting impact of some mitigating
stabilising factors: this exercise will be aided by the arrival of the incoming hard data on
macroeconomic outcomes in the first months of 2019.
At the structural level, longer-term prospects depend on the traditional determinants of global
productivity (such as investment and innovation rates), the steady-state cross-country
distribution of national income levels relative to the frontier and demographic trends. In addition,
climate change (together with the international policy response) will exert an increasing influence
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on the path for global output.
However, both short-term and long-term prospects are currently also subject to an unusually
high level of uncertainty about the paradigms governing policymaking. At the global level, the
primary focus is on the future of the multilateral policy framework underpinning international
trade. Within Europe, Brexit constitutes another paradigmatic shift: the departure of the United
Kingdom from the European Union represents a disruptive event across many dimensions,
including the operation of the single market. A full analysis of such paradigmatic events requires
a multi-field integrated approach that draws upon history, political science, international relations
as well as economics and finance. I will not attempt such a comprehensive approach in this
speech: rather, I will focus on some of the implications of Brexit for the Irish economy and the
Irish financial system.
The Central Bank of Ireland has been focused on Brexit risks since the announcement of the
2016 UK referendum. Our work has focused on ensuring that: (i) the risks to the Irish economy
and consumers are understood; (ii) regulated firms prepare appropriately for all scenarios, in
order to protect consumers; (iii) where necessary, the required policy and legal adjustments are
prepared to counteract the cliff-edge risks of a hard Brexit to the delivery of vital financial
services; and (iv) we perform our gatekeeper role in a robust and efficient manner for new firms
seeking authorisation or existing firms revising business plans.
We have taken a transparent approach to this work: we publish the work of our Brexit Task
Force, release answers to frequently asked questions, hold stakeholder roundtables, and have
published a series of analytical reports and speeches. This research and analysis both informs
our own work and seeks to assist other policy makers and stakeholders.
In what follows, I will first discuss the domestic macroeconomic implications of Brexit before
turning to its impact on the financial system.
Brexit and the Irish Economy
The Irish economy expanded at a strong pace in 2018, supported by the strength of activity on
the domestic side of the economy and a still-favourable international environment. Looking
ahead, the Central Bank's latest central projection is that the outlook for the economy remains
broadly positive, even if some moderation in growth is in prospect. This moderation partly reflects
the limits imposed by domestic capacity constraints due to the tightening of conditions in the
labour market and current bottlenecks in the housing market. It also is the domestic counterpart
to the pullback in the international economic environment, even if this is partly offset by the
expansion in domestic government spending.
We have also explored the scenario of a sudden and disorderly Brexit, using a range of modelling
approaches. In view of the deep adaptation of the Irish economy to a EU28 single market that has
included Britain, a sudden, no-deal scenario would have immediate disruptive effects that would
permeate almost all areas of economic activity. The agri-food sector would be disproportionately
affected, with a corresponding outsized impact on rural regions, especially near the Border.
Our modelling work suggest that a disorderly Brexit could reduce the growth rate of the Irish
economy by up to four percentage points in the first year. In addition to the direct disruption to
international trading arrangements, adverse developments in the UK economy have a general
spillover impact in Ireland, via export demand, the value of Irish-owned operations in the UK,
asset prices and confidence effects. Moreover, a significant further depreciation of Sterling
against the euro would adversely affect those firms dependent on the UK market, even if there
are some offsetting positive effects for domestic firms through the favourable impact on the
terms of trade.
Given the current favourable forecasts for the economy as a result of domestic demand and the
strong non-UK multinational sector, our assessment is that there would still be some positive
growth in output this year and next even under a no-deal scenario, but materially lower than in the
central forecast. A further mitigating factor is that the state of the public finances will permit the
running of a counter-cyclical fiscal deficit through the operation of the automatic stabilisers on tax
revenues and transfer payments.
Brexit and the Financial System
The scale and complexity of the Irish financial system is increasing as a result of Brexit. Well
over one hundred firms have applied for new authorisations or permission to expand their
existing businesses. While some of these applications relate to firms that now plan to serve Irish
customers directly rather than through a UK entity, most of the volume is driven by
exportorientated international firms that will serve EU27 customers from an Irish base.
Our gatekeeping role is critically important in maintaining the integrity of the EU27 single market
in financial services market and protecting consumers, whether resident in Ireland or elsewhere
in the EU27. It is imperative that any new firm authorised here meets the high standards that are
expected of any entity authorised in the EU. Equally, we have engaged closely within the Single
Supervisory Mechanism and the European Supervisory Authorities to ensure that similar
regulatory and supervisory approaches are adopted across the EU27.
More generally, within the framework laid out in legislation, the post-Brexit EU will have to develop
and implement a revised supervisory approach that recognises the shift in the geography of
cross-border trade in financial services within the EU27, with less reliance on the UK as a
bilateral trading partner and more reliance on newly-formed and expanded connections across
EU27 member countries. In addition, in meeting their individual mandates, EU and non-EU
regulators will have to work together in the supervision of large financial groups, in view of the
ongoing intra-firm sharing of technology and services platforms and inter-linked balance sheets
between EU entities and non-EU entities (including UK entities).
A strategic priority for the Central Bank of Ireland is to increase further our engagement in the
relevant EU and international fora in order to contribute our own expertise in shaping this new
agenda. This is a continuation of the substantial effort we have made since the international
financial crisis in actively contributing to the shaping of international regulatory and supervisory
standards.
On the basis of the work that we and others have undertaken, I am satisfied that the immediate
cliff-edge risks of a hard Brexit have been largely addressed. In addition to the preparations by
individual firms, this has included the temporary permission by the European authorities for the
UK central securities depository (CSD) to continue to serve Irish securities during the transition
to an alternative EU27 CSD arrangement.
There are some remaining risks of consumer detriment. The Irish and UK financial systems are
closely connected, with UK firms and firms from Gibraltar providing financial services to Irish
consumers, including insurance and payment services. We have worked with the European and
UK authorities to ensure that those firms providing services to Irish consumers are able to
continue to do so in the event of a hard Brexit. The vast majority of UK-based firms have taken
appropriate action, but not all have to date. In this context, I am pleased that the Central Bank of
Ireland has worked with the Department of Finance to support the drafting of legislation to create
a temporary run-off regime that will protect insurance customers in event of a no-deal Brexit.
In terms of financial stability risks, our assessment is that the improvements in the resilience of
the financial system over the last decade provide a vitally-important buffer. Taken together, the
more balanced macroeconomic profile, the restructuring of the Irish banking system, the
muchhigher capital and liquidity ratios, the decline in the non-performing loan ratio and the more
intrusive supervisory regime mean that the capacity to absorb negative shocks is much greater
than in the past.
Conclusions
While there remains much uncertainty about the final nature of Brexit, the Central Bank of Ireland
(and, more generally, the international central banking and regulatory community) has been
active since the calling of the referendum in preparing for the full range of Brexit scenarios. Our
near-term focus is in ensuring that our contingency planning covers the unfolding situation, while
continuing to work with those firms that have not yet finalised their Brexit plans. Regardless of the
precise outcome, the intrinsic discontinuity represented by any form of Brexit means that it is
certain the 2020 edition of the European Financial Forum will be discussing a
fundamentallydifferent European financial system compared to the system that has been in place for the last
several decades.
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See for example Lane, Philip R., (2019), Climate Change and the Irish Financial System, Economic Letter, Vol.
2019, No.1, Central Bank of Ireland