Moody's: UK banks face increased funding costs and challenges to operating models amid uncertainty around Brexit vote

Banks operating in the UK face moderate short-term risks as the country approaches the June 23 Brexit referendum, says Moody's Investors Service in a report published today. In addition, in the event of a Brexit, banks will likely face more durable but moderate challenges.

Moody's report, entitled "Banks - UK: Brexit Vote Risks Include Higher Funding Costs, Challenges to Operating Models," is available on www.moodys.com. Moody's subscribers can access this report via the link provided at the end of this press release. The rating agency's report is an update to the markets and does not constitute a rating action.

"Uncertainty before the referendum, which would be exacerbated in the event of a vote to leave the EU, has contributed to an increase in UK banks' wholesale funding costs" says Carlos Suarez Duarte, a Vice President-Senior Analyst at Moody's.

UK banks' wholesale funding spreads increased in Q1 2016, with senior unsecured bond spreads 30 basis points wider than at the start of the year, according to a Bank of England survey. In addition, the average credit default swap (CDS) premium for large UK banks increased by about 57 basis points in Q1 2016 compared to 35 basis points for European peers.

The rating agency also expects more muted credit growth in the run up to the vote, particularly if polls indicate that the vote will be close. Although credit demand has so far been steady in Q1 2016, since the announcement on February 20, 2016 of the June 23 referendum date, industry surveys show increased risk aversion among UK businesses.

Low credit growth would likely be extended and exacerbated if the UK leaves the EU, in Moody's view, with a subsequent moderate negative impact on the profitability of some UK commercial banks. Retail-oriented banks would likely be less affected in the immediate aftermath of a Brexit since the negative effects of slower growth will take longer to filter through to households, according to the rating agency.

For those banks with cross-jurisdictional exposure, costs could also increase but remain modest. "A Brexit could initially challenge the current operational structures of some UK and international banks which do cross border business between the UK and the EU," explains Mr Suarez. "This is due to the potential costs of relocating key personnel, creating new legal entities and operating model re-engineering to ensure access to the single market."

Moody's expects firms with the largest cross-border exposures to be impacted the most by a UK exit from the single market. US, Spanish and German banks have the highest amount of claims on UK assets, according to data compiled by the Bank for International Settlements.

Furthermore, many large global investment banks -- which have their European capital markets headquarters in London and access the European single market through their branches and subsidiaries -- could be impacted. Other European banks using London as a main capital markets hub could also face additional costs due to costs relating to setting up subsidiaries or the relocation of staff and may choose to progressively downsize their UK activities, in Moody's view.