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EY ITEM Club: Outlook for financial services
Winter 2017-18

Minds made for empowering financial services

EY ITEM Club has long predicted 2018 as being a difficult year for UK Financial Services, and whilst the winter forecast highlights these challenges, the outlook is better than many had hoped.

Read below Omar Ali’s comments on the latest ITEM Club for financial services forecast

EY - GDP - Inflation - Mortgage lending

EY - Omar Ali

For more information about financial services and how we can help, please contact Omar Ali, Managing Partner, UK Financial Services, EY UK.


Banking. The outlook for banking is steady. Inflation is falling and interest rates are forecast to rise gradually this year, albeit from record lows. Banks are undoubtedly already affected by Brexit, but the services they provide to the UK domestic market are going to remain relatively unaltered until the economic impacts of leaving the EU start to play out. Assuming a transition period is agreed soon, the forecast is for UK banking to be relatively insulated from any Brexit impact from now through to the end of the period forecast (2021).

The banking sector will not though be without its challenges this year. Inflation, interest rate rises and lower consumer confidence, increasing opportunities for businesses to raise finance competitively from sources other than the banks, and policy developments, such as the introduction of Open Banking and Ring Fencing will create headwinds.

One of the primary concerns at the time of our previous ITEM Club: Outlook for Financial Services in the summer was the continued surge in consumer credit. Since then, the regulators and many of the banks have warned that the rapid expansion of UK consumer credit since 2013 would be unsustainable if maintained at the same pace. The PRA’s assessment of firms’ consumer credit lending and the recommendations that followed seem to be having an impact. Whilst consumer credit is forecast to grow in 2018, the rate of growth is predicted to fall for the first time in five years, dropping to 3% and then 2.8% in 2019.

Despite this, consumer credit is still growing faster than overall lending. Growth in total bank lending is forecast to slow from 3.6% in 2017 to just below 2% in 2018 and 2019, and is unlikely to improve upon last year’s 3.6% growth until 2021. This is being driven primarily by slow growth in mortgages and a drop in business lending.

Mortgage lending is expected to remain sluggish through to 2021. It is forecast to rise by only 2.4% this year, half the growth rate we saw in 2017, and only small incremental increases are predicted over the next few years. Demand is softening; consumers and businesses remain nervous about making financial commitment in the current economic and political climate. Banks’ balance sheets and capital positions are stronger and appetite to lend remains. As we move towards a deal with Europe, the hope is that appetite to borrow will pick up, supported by Government interventions such as the cut to Stamp Duty for first-time buyers and reductions in the Corporation tax rate.

Despite UK corporate profitability being at near-record levels and the cost of borrowing remaining low, business lending is still forecast to decline by 0.9% this year, following 2017’s 4.6% fall. This disconnect reflects the growing attractions of other sources of finance such as bond issuance. In 2019, we expect to see business lending recover, with a £5bn cash injection into businesses, but this remains low by historical standards.

The good news for banks and borrowers is that there are no obvious or anticipated economic triggers for a downturn in credit quality. There has, however, been a recent change in accounting policy, which is yet to fully play out. 2018 is the first year in which banks are required to use IFRS 9 (the new International Financial Reporting Standard) on their loan books. It will be worth watching how this affects banks’ provisions and capital ratios, as this may have a knock on impact on investor perceptions and banks’ lending behaviour – especially for higher risk credit.

Insurance. The insurance sector is set for another mixed year. Normally, given the relatively benign economic conditions, insurers would be beginning to feel pretty positive about the outlook for their businesses over the next few years, but with so many factors driving uncertainty, volatility and cost for insurers, the enthusiasm for 2018-2021 has been dampened. This is particularly true in the specialty market, where the risks of Brexit are having the greatest impact.

Overall, the forecast is for non-life premium income growth to remain relatively steady, rising by around 3% in 2018 and 2019, following 2017’s 2.8% growth rate. Motor insurers have been buoyed by the recent revisions to the Ogden Discount Rate for personal injury claims and the increase in premiums. Home insurers though, will face growing pressures from the climbing cost of house repairs, largely reflecting an increase in the cost of leak damage and will be impacted by the slowing growth in housing transactions.

The Life & Pensions sector is set for a slightly more positive year. For the first time since 2012, we hope to see a gradual rise in sales of life protection. Despite recent market turbulence, equity prices should perform well, supported by a strong outlook for global GDP growth. Yields on fixed income assets should also benefit as The Bank of England look set to gradually raise interest rates over the next few years, whilst other central banks are also tightening monetary policy. As a result, life premium income is forecast to rise by an annual average of 3.4% from 2018 to 2021.

Wealth and Asset Management. For Asset Managers, economics will not be the challenge this year. The recovery of sterling in recent months against the US dollar will constrain growth in AUM this year. However, the strength of the global economy, pensions policy driving more savings leading to an increase in assets under management, should help bolster the sector. In fact, we predict total AUM will reach almost £15tn by 2020. A big challenge for asset managers remains the asset mix, the need to provide different return profiles, which also represents an opportunity for the government to help channel money from the industry into longer term investment projects in the UK.

So, Financial Services are in a better place than we would have expected to be at this stage in the Brexit negotiations. Most of the underlying businesses and lines in financial services are forecast to grow, if slowly. This is thanks in no small part to how much work the industry is doing behind the scenes to prepare and hedge against the possible fall out and currency volatility.

But it is hard to get excited about the growth numbers predicted and that means the industry will be looking for new drivers of growth. Some of this will no doubt come from the innovation we are seeing across the sector – Open Banking is going to be an important test case for what other sectors could do. But given the current political uncertainty, the industry will be looking for the government and other policy makers to take visible steps to make sure the UK remains a global leader in financial services, creating an environment where world-leading products and services can be delivered for consumers and businesses.