Financial services set for rough ride as Brexit bites - EY

The UK’s financial services industry is facing a period of slower economic growth and market uncertainty as the Brexit decision impacts on both consumer confidence and business investment in the short to medium term, according to the latest EY ITEM Club outlook for financial services.

With consumers, corporates and investors awaiting details on both the timetable for the UK to leave the EU and the results of negotiations, the outlook predicts delayed spending on big ticket items, weaker demand for credit and mortgages and a downturn in business investment.

Previous predictions for the UK’s economic growth, of 2.6 per cent for this year and 2.3 per cent for 2017, have been revised down to 1.9 per cent and 0.4 per cent respectively following the referendum.

For 2018 the forecast has been cut from 2.2 per cent to 1.4 per cent. Unemployment is predicted to rise to 7 per cent and disposable household incomes will rise by only 1.5 per cent in 2017.

For the banking industry assets are predicted to decline to £5.9tn next year, with earnings in the insurance industry also forecast to drop to £8.9bn, the lowest level since 2012.

Although banks have committed to lend, the forecast for slower economic growth means that demand for credit will weaken, with business and consumers less eager to take on debt. Mortgage lending and consumer credit will grow, but at a slower pace than previously hoped. Business lending is predicted to shrink by 1.8 per cent next year, with the recovery in lending now revised back to 2019. Banks will also face a squeeze on net interest margins and depressed profits from lending due to prolonged lower interest rates.

Sue Dawe, head of EY’s Financial Services practice in Scotland, said: “We had hoped 2016 would be the year that total lending recovered to pre-crisis levels, but with the revised economic outlook this looks increasingly unlikely. Whilst banks are still willing to lend, there is a strong sense of ‘wait and see’ from business and consumers as they await details of what Brexit will look like in reality. The impact of this shouldn’t be blown out of proportion - mortgages and consumer credit are still forecast to grow, albeit slower than before, and business lending is going to shrink slightly - the industry is in a good place to see through this ‘holding pattern’ period.”

ITEM predicts that bank assets will decline to £5.9tn in 2017, shrinking until 2019 as a weaker economy curtails demand for loans. Mortgage lending will grow less than 1 per cent on average per year over the next three years compared to 3 per cent in 2014 and 2015 and the stock of business loans will fall to £376bn by 2019, a level last seen in 2005. Although falling demand will impact banks, the sector’s strong capitalisation, with more than £600bn of high quality liquid assets, and support from policymakers, means it is easily able to weather this.

Reduced demand, slower growth in household wealth, and continued low interest rates will squeeze profitability across the insurance industry. Earnings are expected to decline this year for the first time since 2012, falling to £8.9tn. Profits will stabilise in 2018 before climbing back to £8.8bn in 2019. It is expected that the impact of the slowdown, and the implications of leaving the European Union, will not be uniform across the sector, with a divergent picture emerging for life and non-life companies.

Weaker consumer demand will hit general insurers, with car registrations in 2017 to see the first decline since 2011. General insurance premium income is set to rise by only 0.8 per cent in 2017 compared to 2.8 per cent last year. Life insurance will see slightly stronger growth, with insurance premium income to grow 2 per cent in 2017, albeit down from 3.4 per cent in 2015. The demand for Annuities will be depressed as the 20-year gilt yield will average only 1.9 per cent in 2017 compared to almost 4 per cent over the last decade.

For asset managers, the prospect of interest rate rises and investors regaining their appetite for risk has been replaced with a likely prolonged period of low interest rates, volatility in financial markets, and more sluggish growth in household wealth following the Brexit vote.

ITEM predicts that assets under management will likely rise by only 1.5% per year from 2016-2019, compared to 7.7% in 2015, due to increased investor uncertainty and a deteriorating economic outlook.

Fund flows into bonds are likely to outpace other asset classes, despite slower economic growth and the prospect of more quantative easing suppressing yields even further. While that implies a shift away from equities, cheaper share prices will help support demand so that AUM in equities will recover by 2019. The turbulence already seen in commercial real estate means property AUM will fall this year and next, after more than doubling in the previous three years.

Ms Dawe added: “It is clear that the revised economic forecast will affect financial services players in different ways and each sector faces unique pressures. Undoubtedly, the landscape in which financial services firms are operating has altered - consumers and businesses are going to think twice before they borrow, and be careful about what they invest in. It also looks like low interest rates – which affect all sectors - are here to stay.

“But this economic environment isn’t that different from what the industry has been contending with over the past eight years of change and challenge. In fact, thanks to the rigour instilled in their businesses through the crisis, the financial services industry is probably amongst the sectors best placed to deal with this within the UK.”