Cyprus-style crash could hit independent Scotland because banking sector is 1250% bigger than its economy, Treasury warns

The Treasury analysis warns an independent Scotland's banking sector would be 1254 per cent of the entire economy

An independent Scotland could be plunged into a devastating Cyprus-style crash, the Treasury warned today.

If Scotland goes it alone its banking sector would be 1,250% bigger than its national economy, leaving the government powerless to act in the event of a financial crisis.

The would also be ‘significant difficulties’ in guaranteeing customers’ deposits in any Scottish banks which got into trouble, ministers claimed.

Analysis by the UK Treasury reveals how vulnerable Scotland would be if voters back independence in the referendum in autumn 2014.

However the Scottish Government has already dismissed the paper as 'far-fetched' and 'flimsy'.

Scotland Secretary Michael Moore and Treasury minister Sajid Javid launched the report today, arguing that after independence the Scottish banking sector ‘would be oversized, with assets totalling around 1250 per cent of Scotland’s GDP’.

They added: ‘By way of comparison, before the crisis that hit Cyprus in March 2013, its banks had amassed assets equivalent to around 800 per cent of its GDP – a major contributor to the cause and impact of the financial crisis in Cyprus and the ability of the Cypriot authorities to prevent the systemic effects when it hit.’

When the crisis hit Cyprus in March, long queues formed at cash machines as customers scrambled to access their money.

The cash-strapped island needed an £8.5billion package to bailout its lenders, but savers with more than £85,000 in its banks were told they would lose 40 per cent of their money under conditions imposed by the European Union.

The new Treasury analysis also warns that the 2008 taxpayer-funded bailout of Edinburgh-based RBS was only possible with the financial backing of the whole of the United Kingdom.

The UK Government spent £45 billion recapitalising RBS in order to protect the deposits and savings of thousands of  households and businesses, the report says.

The bank also received £275 billion of state support in the form of guarantees and funding.

These bailouts alone would have been 211 per cent of Scotland’s GDP, including the geographical share of North Sea Oil.

‘As a range of independent commentators have noted, Scotland would not have been able to afford such interventions alone.

‘Other countries such as Ireland, Iceland and more recently Cyprus were unable to absorb the implications of the financial crisis on their own.’

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The new study on the impact of independence on financial services and banking, also states that Scotland could have ‘significant difficulties’ providing protection which would match schemes such as the UK's Financial Services Compensation Scheme (FSCS) which protects deposits in UK banks up to £85,000.

It also states that members of defined benefit pension schemes would not be covered by the Pension Protection Fund (PPF), with an independent Scotland required to provide such protection through a similar guarantee fund under EU rules.

Queues formed at cash machines in Cyprus when uncertainty over a bailout for the island's banks caused panic among savers in March this year

Mr Moore said: 'There are a number of reasons why this country, and this city in particular, offer so much as a location for the financial sector," he told the invited audience at the official launch of the document.

'Some of these factors may not be impacted by Scotland becoming independent, like the excellent universities here or the lifestyle opportunity on offer, especially right here in Edinburgh.

'But Edinburgh and Scotland offer even more as a place to do business as part of the United Kingdom.'

The paper is the third in a series of reports assessing the impact of a yes vote in 2014.

Scotland Secretary Michael Moore said Scotland offered more as a place to do business as part of the UK

It argues that the UK can afford to compensate savers if banks get into difficulties, as they did during the 2008 collapse, but an independent Scotland would be required to set up its own deposit guarantee scheme rather than share existing UK schemes.

The paper says: ‘The UK Government lent around £20 billion to the FSCS during the recent financial crisis. Under European law an independent Scottish state would not be able to 'share' the UK's deposit guarantee scheme, such that it covered firms authorised in both Scotland and the continuing UK.

‘The retail deposit market in a separate Scotland would be dominated by only two large banks (RBS and BoS) and, if one of these were to fail, the costs for compensating the depositors would fall almost entirely on the one remaining bank.’

It continues: ‘If Scotland were to be become independent, it could create particular difficulties for the FSCS. In an independent Scottish state, FSCS-eligible deposits held by Scottish firms (and which would therefore be covered by the Scottish compensation scheme) would be over 100% of Scotland's GDP, representing a significant contingent liability of the state - and a much more significant proportion than in the UK as a whole.

‘As was clear from the 2008 financial crisis, where there are doubts about the ability of the sector to meet claims through the compensation scheme, it can be necessary for governments to step in to guarantee deposits in order to prevent deposit flight.’