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Brexit’s Effect On Your Business Model

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Except for those that have been on vacation in a very remote location, all of us have heard or read countless reports about how voters in The United Kingdom (UK) decided to leave the European Union (Brexit), and predictions about the impact to the global economy (Source). This decision will have long-term implications, as UK is the fifth largest economy in the world (Source), and the second largest in the European Union. Thinking strategically about how Brexit and other events that create uncertainty can impact the business model of their credit union is key. Below are brutal facts and a strategic scenario to consider.

Brutal Facts
Margins are squeezed and Brexit can cause more squeezing. On June 1, 2016, the US 10-year Treasury yield was about 1.85%, already very low by historical standards. On the day following the Brexit vote, due to a spike in uncertainty that Brexit created, the yield was down to 1.57%, a decline of 28 basis points (bps) from earlier in the month and nearly 17 bps from the day before. The 10-year Treasury influences the interest rate charged for longer-term loans, such as mortgages.

Germany is the fourth largest economy in the world, followed by UK as the fifth, as noted earlier. As 2014 got underway, Germany’s 10-year government bonds were trading at 1.94% and UK’s were trading at 3.03%. Both rates have been trending downward in order to “jolt lending, spur inflation, and reinvigorate the economy after other options have been exhausted” (Bloomberg, Negative Interest Rates, June 6, 2016). Of particular note, the day following the Brexit vote, Germany’s 10-year bond was trading at a negative interest rate of (0.05%) and UK’s at 1.09%. At that time, Japan, the world’s third largest economy, had a negative yield on its 10-year government bonds.

Strategic Thinking: Rehearse Tomorrow Today
Consider a process which you have regularly scheduled meetings with a team of key players, such as monthly or quarterly, during which the only thing on the agenda is rehearsing tomorrow today, discussed in a previous blog about strategic planning (http://www.cmyers.com/preparing-for-strategic-planning/).

Identify a trend that is happening, such as negative interest rates in other large economies. Create a future scenario in which those trends continue or expand. Ask your team to discuss what that future could look like and list out all areas of the credit union that could be impacted, and be sure to estimate and simulate the financial implications of the scenario, as well as actions the team would consider. Remember, nothing happens in isolation, so combine events.

An example of a scenario about negative interest rates follows. Imagine it is 2018 and the US has slipped into a modest recession, which was triggered, in part, by the uncertainty created in Europe from the passage of Brexit. Loan demand declines and delinquencies increase. The value of the dollar continued to rise as the value of the Euro and British Pound dropped, making US products even more expensive to the rest of the world. Also, increasing uncertainty caused a flight to safety worldwide. The safest investment is US Treasury debt. As a result, the US 10-year Treasury yield is 0.75%, half of what it was at in June 2016, and shorter-term rates, such as the 3-month and 1-year Treasury bills, are paying negative yields. Current 30-year mortgage rates are 2.50% and competitive rates for auto loans to quality borrowers hover around 0.40%. You are being charged 0.10% to hold cash in an overnight account.

  • What is happening with home sales in your area?
  • What is happening with auto sales?
  • Are your savers saving more or less money?
  • How are you pricing your loans?
  • How are you pricing deposits?
  • Are you charging fees on some deposit accounts?
  • Is there an impact to non-interest income?
  • Because the margin is squeezed further, what are alternative sources of income you can leverage?

Resilient organizations are that way for a number of reasons. One is because they rehearse tomorrow today. Leaders of these organizations are deliberate about preparing their organizations for thriving during disruptions. Negative interest rates may not be the next big disruption, but your preparation for it may help you to thrive during other disruptions.