EY ITEM Club Financial Services Spring Forecast 2014

EY ITEM Club Forecast: Outlook for Financial Services Spring 2014

Forecast for Banking

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After contracting in 2012 and 2013, banks’ assets should see a modest rise this year from £6.5t to £6.7t, but profitability will remain subdued. Consumer credit should continue to expand by an average 4% a year during 2015-18. But business lending is expected to remain restrained, with only a 1.5% rise in 2014. We expect a 2.8% increase in mortgage debt in 2013, but rising house prices are unlikely to signal a mortgage boom.

“With the economy recovering, now is the time for banks to show shareholders, including the UK Government in some cases, that they can achieve meaningful revenue growth.”
 
Omar Ali
Partner, UK Banking & Capital Markets
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EY - Omar Ali
Omar Ali
Partner,
UK Banking
& Capital
Markets

The continuing improvement in the UK’s economic outlook should be music to the ears of UK banks. However, the major banks’ full year results for 2013 show that the sector still has a long way to go in order to get back on track. The banks’ greatest challenge is to rebuild their return on equity to an attractive level. The sector can still do more to reduce costs, but greater efficiency alone is not enough. With the economy recovering, now is the time for banks to show shareholders, including the UK Government in some cases, that they can achieve meaningful revenue growth.

Therefore, it is disappointing that our latest forecast predicts only gradual growth in bank lending. House prices may be rising, but predictions for mortgage lending are relatively modest. And forecasts for business lending growth in 2014 have been revised down from 2.5% to just 1.5%. Although securitization markets are showing signs of recovery, the impact of regulation and the underlying strength of investor demand remains unclear. This means that securitization is also unlikely to have a material short-term impact on new lending. ↓ [... more]

If the banks are struggling to achieve lending growth, they are finding it even harder to reverse pressure on their net interest margins. Base rates are expected to remain extremely low in the short term, and when they eventually do rise, strong competition will maintain pressure on banks’ average spreads.

The effects of competition are also being felt elsewhere. The first six months of the Current Account Switch Service have seen retail switching rates double, despite the poor transparency of the UK’s current account pricing. So far, this has had a limited impact on the big four, as much of the switching has occurred solely between these banks, but that will change as awareness of alternatives grows. Given that charges are the strongest driver of switching in the UK,fee income looks like another uncertain source of revenue.

So, is building revenues an impossible task for UK banks? Not at all. Challengers, such as online bank, Atom, clearly see room for alternative models in terms of price, service and innovation. Incumbents need to respond in kind – anything less and investors will doubt the speed at which the sector will return to a position of strength.

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Banking highlights:

  • We expect the stock of mortgage debt to rise modestly to £1.1t by the end of 2014, 2.8% higher than a year earlier. House prices are expected to rise by 7.4%, with growth averaging just over 5% from 2015–2018.
  • With the employment and earnings picture brightening, credit risk faced by banks should fall. We forecast write-off rates on consumer credit to drop to 2.1% by 2015 compared with a peak of 5.5% in 2010.
  • Business lending is likely to see only a modest 1.5% rise in 2014, and subdued growth thereafter means that lending will still be 10% below the 2008 peak in 2018.
  • Bank Rate is expected to start rising in the second half of 2015, and we expect it to increase by 2.5 percentage points by the end of 2017. This should be accompanied by a smaller rise in market rates, as spreads narrow to more historically normal levels.