On June 24th 2016, the citizens of the United Kingdom voted for the EU referendum, better known as Brexit, and with a majority of almost 52% decided to leave the European Union. Weeks and even months before this event took place, the financial world analyzed and tried to assess the outcome of such an event and began its preparations.
In general, banks are constantly faced with liquidity risks as they might be unable to meet their financial obligations when they come due. A bank might lose liquidity if it experiences sudden unexpected cash outflows by way of large deposit withdrawals, large credit disbursements or an unexpected market movement – Brexit for example.
Many commercial banks in the UK, prior to Brexit, raised tens of Billions in more liquid assets, which is more than half of their annual funding requirements, in order to have enough available capital to prevent businesses and thus the market from stagnating.
In addition, some banks and financial institutions kept trading currencies to the bare minimum in order not to be too exposed to possible fluctuations in the British Pound (GBP) exchange rate. Similarly, central banks, like the Bank of England, The US Fed and the German Deutsche bank, were prepared to help the commercial banks with their potential liquidity problems by raising hundreds of billions in high quality liquid assets.
To better understand what financial institutions did exactly, we can take Covercy for example, a Fintech company that deals with cross-border payments. As Covercy deals specifically with foreign currencies, it had the need to minimize its exposure of the GBP and the Euro (EUR) in case of either of the two outcomes. Minimizing the exposure was done it two ways, the first, by increasing the spread on the mid-market rate, which gives the needed flexibility for the system to execute the transaction in time, before the market conditions change drastically. The second, by keeping a very low amount of capital of the two currencies, which means that the depreciation of a currency would not translate into large financial losses.
Both banks and financial institutions focused on increasing their liquidity and minimizing their currency exposure in preparation for Brexit. Since Brexit, we already noticed that the GBP dropped to its lowest level in about 30 years, although slightly recovering since, due to the banks’ intervention, it is still unclear how the market will behave in the time to come and if the preparations were sufficient for the market as a whole.