Up to 0.2 percent of the European Union's GDP could be erased as a result of the spiralling costs of cross-border travel and disruption to internal trade that would return to post-Schengen Europe, Morgan Stanley warned. The bank's analysts estimate a 5 percent surge in the cost of cross-border travel, while trade flows between countries could fall by up to 20 percent due to border checks as waiting times are reintroduced to Europe.

Unlike the process of negotiating an EU exit for Britain, Morgan Stanley said a chaotic dismantling of the 30-year old passport-free zone would plunge the EU into political turmoil. "Contrary to the Brexit process, which would follow an orderly legal procedure if implemented, the risk surrounding a suspension of Schengen is that it could lead to disorderly political developments related to border controls, which in turn could cause a material hit to private-sector confidence", said Elga Bartsch, at Morgan Stanley.

"This uncertainty would likely lead to a material decline in investment spending, especially if the suspension of Schengen coincided with an exit of the UK."