If the Scottish National Party (SNP) wins a majority in the Scottish parliament elections this May, it will push for a second independence referendum by 2024, according to draft legislation.
This is no small risk for UK banks and their investors – despite recent fighting inside the nationalist cause between first minister Nicola Sturgeon and her predecessor Alex Salmond.
Support for Scottish independence has been gradually rising during the past five years, due to Sturgeon’s high popularity and instability in Westminster, especially over Brexit.
As Scotland voted to remain in the European Union in 2016, Sturgeon has used Brexit to argue for another referendum on independence, Salmond having lost the last one in 2014.
But Scottish independence could cause even more chaos than Brexit, because the EU is not a state and the UK was never in the eurozone.
Frustratingly, Brexit makes Scottish independence harder, because the EU can no longer provide a common umbrella for trade, even if Scotland were to re-join. Scotland is much more reliant on trade with England than the UK is with the EU. It also shares much more administration with the rest of the UK than the UK did with the EU.
Meanwhile, in terms of the banking sector, it is ironic that the devolution of powers to a new Scottish parliament in the late 1990s coincided with a process by which Scottish banks ultimately became less independent.
Royal Bank of Scotland (RBS) was a proudly Scottish-led institution when it bought NatWest around the turn of the millennium. Bank of Scotland sought to catch up by merging with Halifax and was then bought by what is now Lloyds Banking Group.
Both groups are now in effect run from the City of London, although their registered offices are in Edinburgh.
The sheer extent of this entanglement is why, in 2014, the financial question was so decisive. Uncertainty over the future currency came to encapsulate the practical difficulties of implementing Scottish independence. The UK government ruled out Salmond’s hope of a monetary union, which could have been the easiest thing for Scotland and the banks.
This time, the SNP seems more prepared politically.
Its plan now is to use sterling without a formal monetary union, in a sort of managed sterlingization. This would entail setting up a new local financial regulator and lender of last resort in the form of a Scottish central bank, whose job it would also be to prepare for a potential move to a separate currency later.
Lost revenue and jobs, though, could be the least of Scotland’s post-independence banking-sector worries
However, the problem of sterlingization for the banks is that a Scottish central bank’s ability to act as a lender of last resort would be limited, as the UK would retain a monopoly on printing sterling. Scotland would have to fund its central bank through debt or taxes.
Further details of how the currency policy works in practice will become clear later and will be subject to the stance taken on both sides of the border.
The Bank of England or the Scottish central bank, for example, might require banks to ringfence their Scottish operations, lowering the latter’s liabilities. This could be appealing to some Scottish politicians, who have previously argued for a break-up of UK banks that would basically entail a return of the old RBS and Bank of Scotland as primarily Scottish institutions.
What is certain is that Scottish independence – whatever form it takes – would be highly disruptive, costly, and risky for both banks and the economy, especially in the short term.
NatWest, as RBS now calls itself, has already said it could move its headquarters if independence happens. Lloyds would probably do the same.
It is hard to see how this wouldn’t entail a further flow of revenue and jobs south, which could complicate the SNP’s ambitions for Scotland to be a stronger rival to London as a financial centre, and a post-independence bridge between the UK and the EU.
Lost revenue and jobs, though, could be the least of Scotland’s post-independence banking-sector worries. More serious would be the risk of capital flight and a protracted credit crunch. If things went badly, UK banks with smaller Scottish operations could quit the country.
The banks that remained, whether or not fully carved out, would also have to manage their operations according to their views on the risks and perceived risks in the new institutional architecture of Scottish money. Depositors would take a similar attitude.
The SNB needs to be open about the challenges here.
Long term
Perhaps, as in Ireland, some years and even decades of pain could eventually be worth what might be multi-generational benefits of separating from the rest of the UK.
However, establishing fiscal credibility after independence will be all the more difficult given Scotland’s bigger deficit than England’s. London-imposed austerity has helped fuelled the SNP’s popularity, as it has tilted to the left under Sturgeon. More cuts are the last thing its voters want.
The reality is that we wouldn’t know for decades, even centuries, whether Scottish independence had been a success – an uncertainty that also extends to what Scottish independence means for the remaining whole or the constituent parts of what are now UK and Scottish banks. Many bank investors won’t wait to find out.
