The new Scotland Analysis paper on Financial Services and Banking published by the UK Treasury today makes inter alia the point that in an independent Scotland
"The Scottish banking sector would be exceptionally large compared to the size of an independent Scotland's economy, making it more vulnerable to financial shocks than it is as part of the larger UK."
Scotland's Finance Secretary John Swinney's response, to an issue that I have raised in this blog, for example, here, seems to be two-fold.
First, new regulatory provisions since the financial crisis will prevent such crises from happening, as in this quote:
"The Treasury paper seems to be based on a flawed, outdated view of the world which takes no account of the substantial banking reforms which have been ongoing across Europe since 2008."
Secondly, even if such a crisis occurs again financial services are less important to Scotland than they are to the UK as a whole, as in this quote
"Assertions and claims about Scotland's financial sector are entirely misleading - in terms of share of GDP, in fact, financial services are actually smaller for Scotland at 8.3% than the UK at 9.6%. So, if the argument is about risk, then the risk is with the UK."
Both of these responses are facile and in serious error.
While regulatory reform of banking is welcome no one seriously believes that the risks of a serious banking crisis in the future are much reduced. Some such as Andy Haldane of the Bank of England believe progress in this regard will have only been achieved when the size of banks and UK banks in particular is reduced. Others, including this distinguished academic in the field, believe that banking crises are an ever-present risk in capitalist economies.
Secondly, when Andy Haldane talks about size he is not referring to value added but to the size of the assets, or loans and investments, of the bank. As we see in this chart from the new Treasury paper the current size of banking sector assets would be 12.5 times GDP in an independent Scottish state compared to just under 5 times GDP in the whole of the UK.
Implicit in John Swinney's use of the GVA figure is the belief that because the Scottish banks have much of their business located abroad, there would automatically be an international solution if there was a need for a bailout of the 'Scottish' banks. But this flies in the face of the experience in the banking crisis of 2008-09. It is worth recalling Governor of the Bank of England Mervyn King's comment that
"Banks live globally but die locally."
What John Swinney and the 'Yes' campaign need to do is to first of all accept that there would be issues for an independent Scotland given the asset size of its banking sector. Following a serious crisis some international solution could be possible but it will not be automatic as John Swinney seems to imply.
The 'Yes' campaign and the Scottish government need also to address some of the other issues raised by the Treasury report and noted by Robert Peston in his blog today.
First, it is not simply a question of whether the banking sector could be bailed out in the event of bank failure in an independent Scotland. There is also the question of whether banks would have access to sufficient liquidity from the Central Bank if commercial sources of finance dry up as they did following the collapse of Lehman's in September 2008 and the eurozone banking crisis in 2012. This would depend crucially on the currency arrangement adopted by the government of an independent Scotland. And if access to liquidity from the Bank of England is desired then this could only occur if an independent Scotland was a member of a formal sterling currency zone with all that would imply in terms of restrictions on Scottish government fiscal policy and bank regulation.
Moreover, if the financial markets believe that an independent Scottish government will not have as deep pockets, or have access to deep pockets, as the UK government, then they may be more reluctant to lend to the banks, or would charge higher rates. Borrowing costs for the Scottish banks could therefore be higher.
Taking such circumstances together the risk of the two main Scottish banks relocating their headquarters outside Scotland would clearly be high.
John Swinney's glib responses today in no way address any of these issues.