Business conditions for UK financial services sector still lacklustre

The decline in sentiment in the UK financial services sector continued unabated, but volumes stabilised after six months of decline, according to the latest Financial Services Survey by the Confederation of British Industry (CBI) and PwC.

The quarterly survey of 79 firms found that optimism about the overall business situation in the financial services sector plunged again, but at a slightly slower pace than in the previous quarter (itself the sharpest fall in optimism since December 2008). This decline was principally driven by the banking, finance houses and life insurance sectors. Optimism in the sector has now been flat or falling for three and a half years.

Overall business volumes stabilised after two quarters of consecutive falls, but conditions varied significantly across financial services sectors. The greatest drag on growth came from the general insurance, banking (which saw the fastest fall in growth since September 2013) and investment management sectors. Meanwhile, building societies and finance houses saw robust growth. Looking ahead, overall business volumes are set to fall sharply.

Cost pressures picked up, registering the strongest growth since March 2018. Nevertheless, profits continued to grow, although at a much slower pace. However, the subsector breakdown showed some variation: profitability in building societies fell at the fastest pace in ten years, while the banking sector saw the quickest decline since December 2010. All other subsectors saw unchanged volumes or volumes growth last quarter. Overall profitability is expected to be flat over the three months ahead.

Meanwhile, employment across financial services grew at the fastest pace in a year after a decline last quarter. Overall employment growth is expected to edge higher over the next three months.

New PM must resolve the Brexit impasse, avoiding “no deal”

CBI Chief Economist Rain Newton-Smith commented: “Clouds continue to hang over the financial services sector. Optimism has been flat or falling for three and a half years, while business volumes are weak and investment is suffering.

“For three years, uncertainty has held back this vital sector of the British economy. The new Prime Minister’s first priority in office must be to resolve the Brexit impasse, avoiding a ‘no deal’ outcome, and get on to negotiating an ambitious agreement on services with our largest trading partner.

“The financial services sector is the jewel in the UK’s economic crown. A good deal with the EU will support its growth and enable it to focus on the opportunities of the future, from FinTech to Green Finance.”

“Three key interdependent themes emerging”

Andrew Kail, Head of Financial Services at PwC, said: “The financial services sector is in a relative state of flux. Business sentiment remains depressed, but trading levels are stable. However, the wider industry is still in a strong position to drive positive change for consumers and achieve higher levels of performance. The results of this latest survey show three key interdependent themes emerging: focus on people, investment levels, and commercial opportunity.

“Firms are using emerging technologies to enable rapid innovation, alongside capitalising on the opportunities for growth. Analysis from PwC suggests there could be a £100 billion boost if the sector harnesses the technological innovation in the pipeline between now and 2030.

“Finally, as Brexit negotiations remain unresolved, firms who have been hard at work with contingency planning in recent quarters are no longer treating it as an ‘elephant in the room’ – they would simply settle for some clarity on the ‘room’ itself at this stage.”

Investment intentions are mixed

Looking to the year ahead, investment intentions are mixed. While spending on training remains above average and IT spending continues to expand at a historically strong pace, investment in land and buildings and on vehicles, plant and machinery is set to be cut back, and planned marketing spend is the weakest since September 2015. Investment is largely motivated by the desire to increase efficiency and speed (the highest since March 2015), with concerns about demand uncertainty the predominant brake on spending.

Asked what the main strategic driver of their most recent deal was, firms cited talent acquisition and product diversification as the most important reasons. In terms of the top business priority for financial services firms over the next six months, IT or technology-led transformation was named the most important, closely followed by targeting new market segments and expanding into new sectors.

Key findings from the survey

  • Optimism in the financial services sector continued to drop at a fast pace, the fourteenth quarter of flat or declining sentiment.
  • 2% of firms said they were more optimistic about the overall business situation compared with three months ago, while 34% were less optimistic, giving a balance of -32% (compared with -43% in previous quarter).
  • 30% of firms said that business volumes were up, while 33% said they were down, giving a balance of -3% (following -12% in the previous quarter).
  • Looking ahead to the quarter to September, business volumes are expected to fall sharply. 9% of firms expect volumes to rise next quarter and 32% expect them to fall, giving a rounded balance of -24%.

Incomes, costs and profits

  • Overall profits growth slowed in the three months to June, with 28% of firms reporting that profits had increased and 21% saying they had fallen, giving a balance of +7%, compared with +21% in the previous quarter.
  • Income from fees, commissions and premiums grew slightly (+7%), but is set to fall over the quarter ahead (-11%).
  • Income from net interest, investment and trading declined sharply (-26%) with a slightly slower fall expected in the next three months (-15%).
  • Total operating costs rose (+20%), while average costs fell (-9%). Next quarter, total costs are expected to grow at a similar pace (+22%) while average costs are set to return to growth (+7%).

Employment

  • 26% of financial services firms said they had increased employment, while 13% said that headcount had fallen, giving a balance of +13%.
  • Employment growth is set to pick up further next quarter (+19%).

Investment over the next 12 months

Over the year ahead, financial services firms expect increases in spending on IT and training, but to cut back on other forms of capital spending:

  • IT: +61%
  • training: +16%
  • marketing: -6% (the weakest expectations since September 2015: -6%)
  • vehicles, plant and machinery: -12%
  • land and buildings: -15%.

The main reasons for authorising investment were:

  • to increase efficiency/speed (87% of respondents, highest since March 2015)
  • for replacement (55%)
  • statutory legislation and regulation (52%).

The main factors likely to limit investment were:

  • uncertainty about demand (59% of respondents)
  • inadequate net return on proposed investment (39%)
  • shortage of labour, including managerial & supervisory staff (29%).

Business expansion over the next 12 months

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

  • competition (58% of respondents, the highest since March 2018)
  • level of demand (57%)
  • statutory legislation & regulation (53%).

Drivers of recent deals

Asked what the main strategic driver of their most recent deal was, financial services firms cited:

  • talent acquisition (34%)
  • product diversification (26%).

Top business priorities over the next 6 months

Asked what the top business priorities are for financial services firms, those that were ranked the highest were (higher rank indicates greater importance):

  • IT or technology led transformation (5.39)
  • targeting new market segments and expanding into new sectors (5.21)

In related news …

The CBI’s latest monthly Growth Indicator, released yesterday, showed that UK private sector activity in the three months to June contracted at the quickest pace since September 2012, with the balance of firms reporting growth at -13%.

The composite measure based on 546 respondents showed the sharpest fall in distribution volumes since August 2009, while activity in the services sector continued to fall at the fastest pace since December 2012. Meanwhile, manufacturing output was broadly flat in the three months to June, affected by the changed timing of car production shutdowns.

Looking ahead, private sector activity is expected to be broadly stable in the three months to September (-1%) across all sectors.

The CBI Growth Indicator follows other recent data that suggests UK economic growth has slowed noticeably in the second quarter of 2019, as the boost from stockpiling activities in Q1 fades. The CBI expects underlying growth to remain subdued, with risks from Brexit and global trade tensions remaining high.

For more insights into the latest economic data, email me or call me on 020 7099 2621.