Brexit shook the global economy and shattered the illusion that all’s well after the volatility storm at the beginning of the year. While the world was rooting for “Bremain,” the voters in U.K. decided to exit the European Union (EU) in a referendum on Friday, which came as a bolt from the blue for financial markets across the globe.
Pre-Brexit Backdrop
Deeper slump in several major economies including Europe and weaker-than-expected expansion in the U.S. dampened the hopes for any improvement in the global economic outlook. However, expectations of another rate hike in the U.S. despite negative policy rates in some developed economies kept hopes for growth alive.
The European Central Bank struggled to drive regional growth and inflation after the 2008 financial crisis through stimulus and strengthening of its negative interest policy. The European economy covered up its vain efforts to jumpstart the eurozone by cutting interest rates. Despite these, several European economies are still stressed over softened growth and zero inflation.
Brexit Spillovers
Apart from global worries like volatile oil and commodities prices and deep-seated problems in China’s economy weighing on the markets, the world now has to worry about the economic and political uncertainty as a result of Brexit. The U.K.’s decision to exit the EU will undoubtedly make matters worse for the European economy, which is already plagued by fundamental weakness.
Therefore, it wasn’t a surprise that the global markets didn’t take the news in good spirit. European banks such as Credit Suisse Group AG CS and Deutsche Bank AG DB plunged more than 23% and 22%, respectively, in the last two days since the “leave” mandate, while most of the U.K.-based banks lost more than one third of their market value.
The U.S. markets were not spared either due to their exposure to the U.K. and Europe on the whole. Major U.S. banks like JPMorgan Chase & Co. JPM lost over 10%, while Morgan Stanley MS and Bank of America Corporation BAC both sank close to 13% since the poll result. The S&P 500 index was pushed in the red for the year.
Aftershocks
In a major political setback, the British Prime Minister David Cameron announced his resignation as Britain voted to leave the EU. Also, ratings downgrade from top rating agencies warned of "an abrupt slowdown in short-term GDP growth" in the U.K. Of course, the break from the EU would have damaging economic consequences for the U.K. economy.
Regulatory differences with the EU would augment over time, impacting trade volumes and reducing the attractiveness of the U.K. for investment. London’s status as Europe’s premier financial hub is now at stake. Risks of job cuts are on the rise as several British banks had warned of moving thousands of jobs in the event of Brexit.
Per a Global Counsel report, existing EU regulations would make it harder for London to serve European markets, particularly for retail banking and euro trading. The UK would also face the huge challenge of renegotiating the existing EU deals that would no longer apply.
Moreover, The Goldman Sachs Group, Inc. GS forecast a mild recession in U.K. by early 2017 post-Brexit. According to Deutsche Bank analysts, U.K. lenders are now exposed to lower loan growth, higher bad loans and greater risks to dividends.
Though Bank of England and the European Central Bank soothed the Brexit pain to some extent by promising to provide liquidity if required, the global markets will remain vulnerable to the fresh bouts of volatility until the effects of Brexit are digested.
3 European Banks Hit the Most
Financial services that account for almost 10% of the U.K.’s economic activity will largely be affected by Brexit. Analysts expect economic growth to be hit, bad loans to go up, funding costs to rise and investment banking revenues to fall following Brexit, putting British banks at a huge risk.
“The UK’s vote to leave the EU will drive tectonic plate shifts in European bank investing. We move to a slow growth/modestly recessionary scenario for UK banks,” analysts at Jefferies said.
London-based Barclays PLC BCS, which provides various financial products and services worldwide, took a bad hit on Brexit. The stock with a Zacks Rank #3 (Hold) has fallen over 37% in the two days since the poll results came out. Moreover, trading of its shares was suspended on Monday morning following heavy losses on the London Stock Exchange.
The bank was expected to be struck hard following Brexit, given its highest exposure to London and the investment banking sector, which will cause its revenues to shrink.
Given the impact of global issues and Europe’s struggling economy, Barclays has been striving to simplify operations and focus on its core businesses. With this aim, the company restructured its business lines into two divisions and plans to divest/close operations that are not strategic. Now with Britain opting out of EU, the bank’s path to recovery has been lengthened.
U.K.-based The Royal Bank of Scotland Group plc RBS provides banking and financial products and services to personal, commercial, corporate, and institutional customers worldwide. Shares of this Zacks Rank #3 company have suffered a decline of more than 37% since the decision. Similar to Barclays, the trading of Royal Bank of Scotland’s shares was halted for some time on Monday as the bank plunged to the lowest level since the financial crisis.
The bank had its ratings downgraded by several analysts as ambiguity surrounding Brexit dominated its earnings outlook. Brexit will further widen the gap that the British banks are trying to close by cutting costs and restructuring to emerge from the long-lasting toll that the 2008 financial crisis took on the U.K. banking industry.
Lloyds Banking Group plc LYG provides banking and financial services to individual and business customers in the U.K. and internationally. This Zacks Rank #3 stock has slumped nearly 36% in two days since Brexit. Several analysts downgraded Lloyds, spelling trouble for the bank in the wake of Brexit.
Amid worries that the dissociation from EU will compel U.K. banks to relocate some of their corporate and investment banking operations to the European continent to preserve access to clients, Lloyds and Royal Bank of Scotland also face the additional threat of a potential Scottish referendum on whether to exit the U.K.
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