The costs of rescuing its banks in a future crisis could leave an independent Scotland even more indebted than Iceland or Ireland
A sterling zone would resemble the euro zone in some ways, with integrated monetary and banking systems but separate fiscal and political ones. This asymmetry made the euro prone to crisis, so unionists fret about the parallels. Mr Osborne fears that just as Germany had to bail out Ireland, Cyprus and Greece to save the euro, Britain might have to rescue a stricken Scotland to protect the two countries’ shared financial system.
Making matters worse, Scotland is home to two of Britain’s largest banks in Royal Bank of Scotland (RBS) and Lloyds, which is based there owing to a quirk of corporate history. If the country became independent it would have bank assets twelve times the size of its GDP. The equivalent multiple for the rest of Britain is below five; for Ireland on the eve of the financial crisis it was about seven (see chart).
In another meltdown, then, Scotland would struggle to rescue its banks. Indeed, although its present fiscal position appears at least as good as that of the rest of Britain, its longer-term prospects are poor. Scotland’s dependence on oil production exposes it to external shocks, and the country is ageing. The Institute for Fiscal Studies, a think-tank, reckons the country will face a larger fiscal gap than Britain even if oil revenues remain strong: 1.9% of national income against 0.8% for the UK.
Mr Salmond was having none of this. In a speech on February 17th he pointed out that a ring fence separating retail from investment banking, due to be implemented by 2019, ought to reduce the chances of another banking crisis. He also said the chancellor had exaggerated the size of Scottish banking assets by including those based in London, such as RBS’s investment-banking arm—implying that an independent Scotland would take little responsibility for them. And the SNP leader predicted that the rest of Britain would surely drop its opposition to a sterling union for fear of the transaction costs—estimated at £500m ($800m)—of separate currencies. He dubbed this a “George tax”.
These reassurances are rose-tinted, to say the least. Splitting investment from retail banking will not abolish banking crises. Nor will it completely absolve sovereigns of liability. Even if the Scottish retail operations of Lloyds and RBS could be hived off during a crisis, someone would probably need to save the banks’ remaining operations. They are globally systemic and remain far too big to fail safely. Scotland would have neither the capacity nor—judging by Mr Salmond’s words—the willingness to save them. The bill would fall to London. Presumably the British authorities would only be willing to shoulder those liabilities if RBS and Lloyds moved their headquarters to London in advance.
The only point I’d add is that if Salmond needs a Plan B on currency, these numbers mean the Euro won’t be it. There is no way that Germany is going to put themselves in the position of potentially bailing out an economy larger than Greece’s. If it can’t get a currency union Scotland would have little choice but to go it alone.