WIREDGOV

Sentiment in the financial services sector deteriorated in the three months to September, as firms digested the challenges of lower interest rates and the uncertainty caused by the vote to leave the European Union, according to the latest CBI/PwC Financial Services Survey.

The quarterly survey of 115 firms – the first since the Brexit vote – found that optimism about the overall business situation fell for the third consecutive quarter, which was the longest period of declining sentiment since the depths of the financial crisis in early 2009. Optimism was broadly stable in the life & general insurance sectors and fell only slightly among banks, but it deteriorated sharply among finance houses, building societies & investment managers.

Meanwhile, firms saw healthy growth in overall business volumes in the three months to September, with only finance houses reporting a drop in activity. Growth in overall business volumes is expected to slow in the coming quarter, but to remain decent from a long-run perspective.

Growth in profits also picked up in the quarter to September, having slowed over the previous year, but is expected to ease back again over the next quarter.

Asked about the effect of the UK’s vote to leave the EU, just over half of all financial services firms said the general impact of the vote was negative, whereas only around one in ten firms pointed to a positive impact. The main cause for concern was market volatility, with just under three quarters of firms reporting a negative impact in this area. In the wake of the vote, the top three risks facing financial services firms are: the impact on the economy; changes in access to EU markets; and the prospect of lower yields.

Rain Newton-Smith, CBI Chief Economist, said:

“As firms get back into the swing of things after the summer, and continue to digest the implications of the EU Referendum, it’s good to see that demand in the financial services sector has held up.

“But the challenges facing the sector have not gone away - they’ve actually grown. Add the uncertainty caused by Brexit to low interest rates, technological change and strong competition, and it’s plain to see why optimism is falling and pressure on margins remains intense.

“With firms voicing strong concerns about the impact of Brexit, especially the risks to the wider economy in the years ahead, the Government must allay their unease with clear plans for negotiations to leave the EU. An ambitious Autumn Statement would also set a clear direction for growth and prosperity.”

Andrew Kail, UK financial services leader at PwC, said:

“Life was busy for UK financial services firms before the Brexit vote - it just got a whole lot busier as they digest the implications for their businesses. The survey shows business performance holding up in the short term which is positive. However, the continuing fall in optimism is a cause for concern. Trading conditions and the 'lower for longer' interest rate environment continue to be challenging. 

"The big picture agenda of transforming business models to respond to customer, regulatory and technological changes continues apace and now Brexit has added an additional ingredient to the mixture.

"It's still early days, and there is no real clarity on what future agreements will be reached. Consequently, many of our clients are considering their options, including potential restructuring and relocation of their businesses. However it’s the domino effect on people, productivity and position as a financial hub that must be guarded against. 2 million people across the UK are directly or indirectly employed by the financial services sector. Financial services firms all depend on the access to talent and market infrastructure, and the business environment. And by extension, so do the many firms using Europe as a springboard into the UK."

Employment was stable in the three months to September, for a second successive quarter. Employment growth is expected to pick up over the next quarter, reflecting rising headcount across most sub-sectors. Training expenditure also continued to expand at a brisk pace.

Investment intentions improved marginally over the last quarter. Growth in spending on IT over the year ahead is expected to remain robust, while firms expect to keep other forms of capital spending broadly steady. Promoting efficiency and regulatory compliance were the most important motivations for investment.

Key findings:

• Optimism in the financial services sector fell for a third consecutive quarter in the three months to September – the longest period of deteriorating sentiment since the quarter to March 2009
• 15% of firms said they were more optimistic about the overall business situation compared with three months ago, whilst 28% were less optimistic, giving a balance of -13% (compared with -16% in the quarter to June)
• 48% of firms said that business volumes were up, while 13% said they were down, giving a rounded balance of +34%. This compares with +22% in June, and +26% in March
• Looking ahead, growth in business volumes is expected to moderate: 25% of firms expect volumes to rise next quarter, and 10% expect them to fall, giving a rounded balance of +14%.

Incomes, costs and profits:

• Overall profitability grew at a healthy pace, with 37% of firms reporting that profits had increased and 13% saying they fell, giving a rounded balance of +24%
• Income from fees, commissions and premiums grew (+25%) at a similar pace to the previous quarter (+23%) with further, albeit slower, growth expected in the quarter ahead (+10%)
• Income from net interest, investment and trading fell (-8%) faster than expected (-3%). A similar decline is expected next quarter (-8%)
• Total operating costs continued to rise (+26%), but growth is expected to slow next quarter (+5%). Average costs fell (-12%), with a further decline expected next quarter (-11%).

Employment:

• 24% of financial services firms said they had increased employment, while 24% said that it had decreased, giving a rounded balance of -1% (compared with +3% last quarter)
• Numbers employed are expected to rise next quarter (+20%), though not in life insurance (-58%)
• Training expenditure grew at a solid pace (+22%), albeit less rapidly than the previous quarter (+31%), with a further slowdown expected next quarter (+14%).

Investment over the next 12 months:

In the year ahead, financial services firms expect to increase IT and marketing capital spending at a faster pace, and to scale back other investments to a lesser degree than in the previous quarter:

• IT: +50% (up from +46% in June)
• Marketing: +26% (up from +19% in June)
• Land and buildings: -4% (up from -9% in June)
• Vehicles, plant and machinery: -4% (up from -10% in June)

The main reasons for authorising investment are cited as:

• To increase efficiency/speed (68% of respondents)
• Statutory legislation & regulation (66%)
• To provide new services (58%)

The main factors likely to limit investment are cited as:

• Inadequate net return (cited by 55% of respondents)
• Uncertainty about demand or business prospects (51%)
• Shortage of labour, including managerial & supervisor staff (28%)
• Shortage of finance (10%).

Business expansion over the next 12 months:

The most significant potential constraints on business growth over the coming year are:

• Competition (cited by 66% of respondents, this has eased from the 88% seen in June, the highest figure since June 2007)
  • 91% of firms see competition coming from within their own sector of financial services
  • 48% see competition coming from new entrants
  • 41% see competition coming from other sectors of financial services
• Level of demand (58%).

Impact of the EU referendum:

• 53% of firms reported that the vote to leave the EU had a negative general impact on their organisation, compared with 12% reporting a positive general impact, giving a balance of -41%
• The main source of concern was market volatility, with 71% of firms pointing to negative impact and 8% reporting a positive impact, giving a balance of -63%

Asked to rank the top three risks over the medium-term, the factors gaining the highest rankings were:

• The impact on the economy (58%)
• Changes in access to EU markets (44%)
• Lower base rate/yields (27%)

Asked to rank the top three opportunities over the medium term, the factors gaining the highest rankings were:

• Changes to UK financial services regulation (32%)
• Acceleration of transformational change (19%)
• The stimulation of new innovation and FinTech (16%).