Carney Says Scotland Can Learn From Euro Crisis in Pound Debate

By Emma Charlton and Jennifer Ryan  Jan 29, 2014 3:15 PM GMT+020

Bloomberg

Scotland will probably need to mirror the euro-region’s integration plans and surrender some sovereignty if the nation votes to separate from the rest of the U.K., Bank of England Governor Mark Carney said.

While First Minister Alex Salmond wants to keep the pound if Scots vote for independence at a Sept. 18 referendum, Carney said policy makers need to “consider carefully” the financial stability risks associated with such a monetary union. Speaking after a meeting today with Salmond in Edinburgh, he said independence will involve “some ceding” of sovereignty.

“The degree of fiscal risk sharing will likely have to be significant,” Carney told business leaders in his first considered remarks on the topic since joining the BOE in July. “The euro area is now beginning to rectify its institutional shortcomings, but further very significant steps must be taken to expand the sharing of risks and pooling of fiscal resources.”

Nationalists want control over Scotland’s finances while maintaining a currency union and the Bank of England as its central bank. The U.K. government has said that’s unlikely to work because the risks would be too great in the event of an economic or fiscal shock.

An arrangement to retain sterling would need to be negotiated between the Westminster and Scottish Parliaments and implemented by the Bank of England, Carney said, according to the text of a speech at a lunch hosted by the Scottish Council for Development & Industry in Scotland’s capital.

Currency Union

“A durable, successful currency union requires some ceding of national sovereignty,” Carney said. “It is likely that similar institutional arrangements would be necessary to support a monetary union between an independent Scotland and the rest of the U.K.”

European officials have accepted that monetary union won’t be complete until there is some sharing of fiscal sovereignty, with options including a transfer union or pooled employment insurance, Carney said. Any approach will likely involve “significant” sharing of fiscal risk.

Even as policy makers work to remove the danger that taxpayers are forced bail out banks that are too big to fail, some link between lenders and nations will persist, Carney said. Banks’ government debt holdings, the need for a national backstop on deposit guarantees, and the central bank’s role as a lender of last resort will preserve the connection, he said.

“The existing banking union between Scotland and the rest of the U.K. has proved durable and efficient,” Carney said. “These arrangements help ensure that Scotland can sustain a banking system whose collective balance sheet is substantially larger than its GDP.”

Banking Industry

The size of the banking industry in an independent Scotland amounts to 12.5 percent of the nation’s gross domestic product, compared with 4.3 percent of the rest of the U.K., Carney said, citing data from 2012. By comparison, he said lenders were equivalent to 7.1 percent of GDP in Ireland in 2007 and 7.4 percent in Iceland.

Politicians should ensure “that Scotland can sustain a banking system whose collective balance sheet is substantially larger than its GDP,” the BOE governor said. “The euro area has shown the dangers of not having such arrangements, as well as the difficulties of the necessary pooling of sovereignty to build them.”

A common currency area will benefit from shared fiscal arrangements, he said. These can help tackle shocks afflicting part of the region and mitigate the loss of exchange rate flexibility. Other positives include reduced uncertainty, deeper financial markets and labor mobility, Carney said.

“Being in a currency union can amplify fiscal stress for individual nations,” he said. “It makes sense to share fiscal risks across the whole currency area.”

To contact the reporters on this story: Emma Charlton in London at echarlton1@bloomberg.net; Jennifer Ryan in London at jryan13@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net