The Bank of England plans to allow European banks to maintain their UK operations under current rules following Brexit, in a direct challenge to European Union regulators to adopt the same policy towards UK-based banks.
The Bank said it wanted to press ahead with assessing the risks posed by the 177 banks and insurance companies based in the European Economic Area that have branches in London, following the agreement between Theresa May and EU officials to move to the second stage of Brexit talks.
In a move that pre-empts trade talks between the UK and EU, the Bank said it would assess each foreign bank’s branch operation to decide whether it needed to be converted into a subsidiary, which effectively separates it from its overseas parent with its own capital.
Banks domiciled in the EEA will be keen to maintain UK branches, which are cheaper to run and come under more direct head office control. They also maintain their chief regulator in their home country.
Most branches are expected to retain their current status despite needing to satisfy stringent rules. The BoE said it would carry out a broad assessment of the risks posed by branches, though it would rely heavily on cooperation with regulators across the EU.
Branches that are considered to pose a systemic risk to London’s financial centre could be forced to convert to being subsidiaries.
The Treasury is expected to give the Bank additional powers to supervise foreign bank branches in the UK, a job largely done by regulators based inside the EU.
Some pro-Brexit campaigners are expected to view the move as throwing away a major bargaining chip in trade talks.
The UK might have threatened to block EU access to facilities in the City as the price of concessions in other areas, such as manufacturing and fishing rights.
However, Mark Carney, the Bank’s governor, told MPs on the Treasury select committee on Wednesday that the decision to allow EU banks to continue operating under existing UK rules had been taken on the assumption that a “high degree of supervisory cooperation with the EU” would continue after Brexit.
It would “not be a good outcome for the system, for Europe or for the UK”, if supervisory cooperation with the EU cannot be maintained as it is for other countries, such as the US, he said.
In an interview with the Guardian on Monday the European Union’s chief Brexit negotiator said Britain cannot have a special deal for the City of London, dealing a blow to May’s hopes of securing a bespoke trade agreement with the bloc.
Michel Barnier said it was unavoidable that British banks and financial firms would lose the passports that allow them to trade freely in the EU, as a result of any decision to quit the single market.
In response to Barnier’s warnings to the City, Carney cautioned that denying UK financial institutions passporting rights would hurt both sides.
“The UK financial system, like it or not, is effectively the banker for Europe, in the most complicated bits of finance,” he told MPs. “There are economies of scale that benefit both sides.”
At prime minister’s questions on Wednesday May said: ““Monsieur Barnier has made a number of comments recently about the opening negotiating position from the European Union.
“ The Bank of England and the Treasury have been setting out today reassurance to ensure that banks will be able to continue to operate and will be able to continue to ensure that the City of London retains its global position.
“But this will be of course part of the negotiations on phase two of Brexit. We are very clear on how important this is.”
As the commission insists the UK cannot benefit from a trade deal covering the City, it is beefing up oversight of financial centres outside the EU.
Currently banks and financial institutions outside the EU can gain access to European capital markets, if the rules in their home country are deemed equivalent to EU standards. Countries such as the US, Switzerland and Australia are deemed to have passed the EU’s “equivalence” test in certain areas of regulation, but the status can be withdrawn at any time.
On Wednesday the commission published draft legislation to tighten up the criteria for equivalence. Some officials have suggested that the draft regulation could mean non-EU firms, including UK financial institutions, seeking high levels of access in the single market are bound to follow Brussels rules on bankers bonuses – capped at twice annual salary.