U.K. banks will be hit worst if the country does not reach an agreement on future relations with the EU before it leaves the bloc March 29, 2019, according to S&P Global Ratings analysts.
"While other largely open European economies, like Ireland, Belgium or the Netherlands, could also feel the impact of a disruptive Brexit, we would expect banks in these countries to be able to accommodate it," the analysts wrote in an Oct. 11 report.
In a no-deal Brexit scenario, the U.K. will likely descend into a political crisis, causing economic contraction that will hit the property market as unemployment rises, according to the report.
Although U.K. banks are well positioned to withstand political and economic shocks with solid earnings and balance sheets at the moment, the negative effects of a disorderly Brexit coupled with an economic slowdown will make them more vulnerable over time and could lead to a change in their ratings and/or outlooks, the credit analysts said.
Smaller banks exposed
Growing unemployment and a drop in investments and consumer spending could cause a surge in personal and corporate insolvencies. This may affect banks' asset quality and put a brake on their activity, which would impair profitability and even their capitalization.
Smaller U.K. lenders are most exposed to those negative effects given their focus on domestic retail and mortgage markets, S&P Global Ratings said.
The banks themselves are getting increasingly cautious as over the next three months they are set to make their biggest cut in mortgage lending since the financial crisis, according to a Bank of England survey released Oct. 11.
Larger banks will also not remain unscathed and are likely to face challenges in licensing and serving their clients post-Brexit, S&P Global Ratings said.
They will be particularly vulnerable to a wholesale market disruption because they operate on U.S. and other non-U.K. debt markets.
"Spread widening or funding disruption for the banks and other U.K. corporates could be more acute if the market perceived the U.K. sovereign to have weakened," the analysts said. The worsening of the macroeconomic environment will deal the most serious blow to the larger institutions as well, they said.
HSBC Holdings PLC and Barclays PLC will be most exposed to the negative effects of Brexit because of their extensive business links to the remaining EU 27 countries, according to the report.
Time running out for deal
In its base-case scenario, S&P Global Ratings expects the U.K. to reach a withdrawal agreement with the EU and a transition period until the end of 2020.
"In this scenario, we anticipate a moderately supportive macroeconomic and funding market backdrop suggestive of a very limited near-term deterioration in the creditworthiness of U.K. and European [financial institutions]," the analysts said.
However, the likelihood that the U.K. will leave without a withdrawal deal and a political agreement on future relations remains significant given the slow progress of negotiations with less than six months left to the Brexit deadline, they noted.
This S&P Global Market Intelligence news article contains information released by S&P Global Ratings, a separately managed division of S&P Global. Descriptions in this news article were not prepared by S&P Global Ratings. The original S&P Global Ratings document referred to in this article can be found in the sources section.