In the run up to President Donald Trump’s state visit to the UK this week, some £1.25 billion of US corporate investments in UK financial services were announced. Alongside this investment, Chancellor Rachel Reeves and US Treasury Secretary Scott Bessent reportedly discussed potential steps to align more closely UK and US capital markets, focusing in particular on digital assets.
However, the policies of the Trump administration look set to increase substantially the financial stability risks in the US economy. Historically, financial shocks beginning in the US have often led to much wider global shocks, from the 1929 Wall Street Crash to the global financial crash of 2007–09. The British government needs to protect the UK against these developments and would therefore be wise to treat initiatives for alignment over financial de-regulation with caution.
Increasing financial risks from the US
President Trump has argued that deregulating the US economy will promote growth and innovation. Keeping regulations up to date and responding flexibly to innovation is important, but current US policies are increasing financial stability risks in four main ways.
The first is through the official campaign to promote private digital assets. New legislation (the GENIUS Act) has been passed to regulate private digital currencies (including stablecoins) and ban the Federal Reserve from issuing a central bank digital currency (CBDC) which might otherwise compete with dollar stablecoins.
Legislation is also in train to clarify responsibility for regulation of other, much more volatile, crypto assets. It is clearly better to have some regulation than no regulation, but the approach in both cases seems likely to be ‘light touch’ while at the same time encouraging rapid growth in private digital assets as a share of US national wealth.
And yet stablecoin issuers have many similarities to banks and should therefore be treated with the same rigour. In theory, they back their liabilities with safe dollar assets and should not take on significant credit or maturity risk. But that needs to be fully enforced, as do systems to protect against cyber security risks and fraud.
Meanwhile the sole source of value of a crypto asset such as Bitcoin is derived from the fact that investors believe it has value. There is no underlying productive investment, guaranteed return, industrial use, or approval by central banks. A recent survey suggested 21 per cent of US adults use crypto assets. The crypto share of US personal wealth is probably still small – the value of all crypto assets, at $4tn, is less than 3 per cent of total US household wealth. But this could change rapidly and increase overall risk in the US economy.
US financial stability risks are also likely to rise due to the Trump administration’s denial of the climate threat. This is combined with actions to roll back federal subsidies for climate investments, to discriminate against climate mitigation investments and to deter private financial institutions from scaling back their involvement in hydrocarbon investments. Together these steps can be expected to raise financial risk through delayed climate adaptation and increased transition policy risk.
These risks could be exacerbated by the Trump Administration’s overall agenda on financial services deregulation. This includes delaying and weakening final stage revisions to international banking standards agreed after the global financial crisis (known as the Basel III End Game). As a result, globally systemic US banks will not be required to hold as much capital as had previously been mandated.
A fourth source of increased financial stability risk is the Trump Administration’s move to weaken the independence of US financial regulators, particularly the Federal Reserve. The administration is also reducing the quantity and quality of data collected by the Federal authorities and has been accused of politicizing, or even personalizing, what were previously seen as technical decisions.
Should the UK follow the US?
Despite this backdrop, the UK authorities have faced strong pressure from the private sector to follow the US in loosening financial regulation for traditional financial services and in new digital finance areas.
Financial services are one of the UK’s most productive economic sectors and have coped surprisingly well with the UK’s withdrawal from the EU. While arguments were made after the global financial crisis that the UK should avoid the ‘financialization’ of its economy, it is in fact quite reasonable for financial services to make up a growing share of UK GDP over time. Global demand for financial services is rising and the UK has a long-standing comparative advantage in their provision. This is also a good reason to avoid imposing ‘special’ taxes on the financial services sector, unless they can be justified by unique costs the sector imposes on the government.
But this does not justify abandoning a gradually evolving and precautionary approach to regulating the sector and maintaining the autonomy of financial regulators. While public and private digital currencies may offer considerable gains in terms of the speed and cost of settling transactions, there is also a major risk that private institutions working with them may not fully appreciate the risks, or may not be incentivised to give them sufficient weight. This is what happened with the securitised assets based on sub-prime mortgages that triggered the global financial crisis of 2007–09.
A financial shock can place an enormous burden on the national economy. The global financial crisis is estimated to have cost the UK government a net £23 billion in direct financial support, while at the peak it was forced to provide £1 trillion in financial guarantees to the private sector. UK GDP dropped by 5.9 per cent from peak to trough during the crisis and took five years to recover. Real wages stagnated for nearly a decade after the shock. Whatever the benefits of light touch regulation in driving tech-driven growth in financial services, they cannot justify risking a further shock of this nature.