Bank of England boss Mark Carney has confirmed that European banks will be allowed to operate under existing rules after Brexit, but warned there will be "consequences" if EU talks do not go as planned.
The Bank's plans mean that European institutions will not need to convert their UK branches into subsidiaries - a move that will ease the burden for the financial services industry, which has urged negotiators to strike a cross-border deal.
The central bank said it made the decision on the assumption that a "high degree of supervisory co-operation with the EU" would continue after Britain leaves the bloc.
In a hearing with MPs after the announcement, Mr Carney cautioned: "Our presumption is consistent with the Government's objectives that we will continue to have a form of supervisory co-operation and information sharing with the EU authorities after Brexit.
"But we retain all our options, and if that is not forthcoming there will be consequences for those institutions."
The Governor added the Bank decided not to take a "glass half empty" view on the outcome of talks, despite warnings from Europe's chief Brexit negotiator Michel Barnier that Britain cannot have a special deal for the City of London.
Mr Carney told the Treasury Select Committee that it did not make sense to tell banks they must create subsidiaries, causing a "tremendous amount of cost and disruption", only to change the guidance if there is a co-operation agreement in the future.
It would "not be a good outcome for the system, for Europe or for the UK", if supervisory co-operation with the EU cannot be maintained as it is for other countries, such as the US, he said.
In response to Mr Barnier's warnings to the City, Mr Carney said: "I don't accept the argument that just because it hasn't been done in the past, it can't be done in the future.
"We'd just walk away from progress if that was the approach."
He also revealed the Bank's plans are based on agreement being struck on a transition period by the end of the March next year.
Subsidiaries in the UK stand as separate legal entities and are required to hold large capital reserves in case of a market crash, which is meant to stop them from pulling out in such an event and taking customers' funds with them.
Those capital requirements do not apply to branches.
There are currently 160 international bank branches operating in the UK, 77 of which are from the European Economic Area (EEA), with assets of more than £4 trillion.
That is on top of 110 foreign insurance branches, with 80 from the EEA.
If foreign banks were forced to convert their branches to subsidiaries after Brexit, it is believed that many firms would decide to leave the UK altogether rather than taking on the additional costs - reported to be in the billions of pounds.
An exodus would subsequently hit government coffers, as financial services account for a large proportion of the UK economy and generate billions in tax, and potentially put thousands of jobs on the line.
Some changes may be introduced for insurers from outside the EU, however.
The central bank currently requires foreign banks from outside the EU, which hold a "material" amount of UK retail deposits, to operate through subsidiaries, and said the approach could be extended to insurers, based on the size of the business.
Catherine McGuinness, policy chairman at the City of London Corporation, said: "Allowing European wholesale banks to operate as normal in the UK after March 2019 is a welcome bit of news to end the year for the City."
"We are pleased to see this development and it is now up to our politicians and regulators to make sure this is delivered," she added.