EU Membership and the 'British Dilemma'

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The impact of European Union (EU) membership on financial services will be at the centre of the referendum debate. On the one hand, membership provides access to the world's largest borderless economic market. But on the other hand, the price of EU membership is giving up the right to independent action on certain areas of financial policy. The key issue will be the benefits from access to the single market, versus any possible limits on financial policy which may increase the risk of future financial failures.The UK has been a world leader in finance for two centuries. It is the largest net exporter of financial services in the world. The UK hosts more overseas banks than any other country in the world and also hosts the largest insurance, wholesale finance and asset management markets in Europe. Finance is also vital part of all our daily transactions, and hence the overall performance of our economy.However, there is a downside to hosting a global financial centre. Chancellor Osborne calls this the "British dilemma": while we enjoy the benefits of the largest global financial centre, the inherent risks are large relative to the UK's tax base. When large banks fail, the buck stops with national governments. The dilemma is even sharper today than seven years ago given our high level of public debt and limited capacity for fiscal support. Former Bank of England Governor Lord King made a similar point that "banks are global in life, but national in death." When large and important cross-border institutions fail, residual losses tend to fall on domestic taxpayers. For example, in 2009 UK tax payers were exposed to more than £1 trillion of losses in the banking sector. This was the cost of having global banks and being a global financial centre.Countries in the Eurozone are responding to the crisis by forming a European Banking Union. This is the most significant integration in the EU since the Maastricht Treaty. When a bank fails, the losses will be shared though a resolution fund and a systemic crisis would require a shared fiscal backstop. This crosses the political Rubicon of sharing taxpayers' liabilities across borders within the EU with far reaching consequences. The current UK Government has made clear that it will not join the EBU.The UK has a number of options inside and outside the EU. One option is to insist that all foreign banks in the UK are individually capitalised and regulated by the Bank of England. This would be similar to the Swiss option outside of the EU. This contradicts branch banking rules under the EU and would put at risk our leadership in global banking. Another option is that the UK stays in the EU and accepts less control over its domestic banking agenda and eventually considers joining the European Banking Union, where some of the risk associated with its large banks can be shared with our European partners. Still another policy option is that the UK remains in the EU and exerts greater influence on European banking regulation (as it has in the past). European banking regulations are made in Brussels but within the global regulations set at the G20 and the Financial Stability Board. The UK has been particularly successful at representing its interests in both forums in the past.Is this last option achievable? If the UK stays in the EU, the single market will have two global currencies (Euro and Sterling), along with two of the most powerful central banks in the world, two supervisors and sets of prudential regulations and two resolution procedures backed by two distinct groups of taxpayers. This does not look like a sustainable 'single market'. This Fellowship will investigate the trade-off, how the UK financial sector could be accommodated within the EU and compare this to the plausible options of being outside of the EU.