EY ITEM Club Forecast: Outlook for Financial Services Winter 2014

Forecast for Banking

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Some banks are expected to start expanding assets again between now and 2016 and the improved economic environment is expected to boost mortgage and consumer lending. Business lending hit a five-year low in 2013, but is set to recover this year (rising 2.5%), however it still remains well below the 2008 peak.

“Increasing competition is likely to be one of the defining issues of 2014 for UK banking.”
 
Omar Ali
Partner, UK Banking & Capital Markets
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EY - Omar Ali
Omar Ali
Partner,
UK Banking
& Capital
Markets

Despite growing economic momentum, the environment for UK banks remains challenging. Persistently low interest rates are not only bad news for savers, but also for banks’ net interest margins. To deliver the returns investors demand, banks will need to offset this pressure by growing their balance sheets or generating stronger fee income and neither of these options are without their difficulties given capital constraints and regulatory focus on fees.

While some banks are expected to begin expanding their assets again during 2014, continued regulatory uncertainty will make this difficult. The full implications of the pending stress tests, discussions on leverage and the Financial Services (Banking Reform) Act for capital requirements and the structure of UK banking are particularly unclear. They could all impact banks’ ability to increase lending and dividends.

Increasing non-interest income will be easier for some banks than others. On one hand, stronger corporate activity is forecasted to give trading and advisory income a boost. On the other, increasing fees and charges in the retail market is politically and commercially challenging. Fees and charges, together with customer service failures, are the leading drivers of switching core banking service providers for both individuals and SMEs. ↓ [... more]

Increasing competition is likely to be one of the defining issues of 2014 for UK banking. We see genuine interest in the retail market from new players convinced they can offer customers something distinctive in terms of price, proposition or customer service. New entrants will benefit from the PRA’s relaxation of capital requirements and the opening of access to payments systems, although IT costs still represent a barrier to entry.

Increasing business and consumer confidence should help new entrants to increase levels of competition in the market. This is already being seen in corporate banking, as alternative lenders step in to fill the gap between businesses’ need for credit and banks’ willingness to lend. There are also opportunities for new retail entrants to fulfil the growing demand for consumer credit.

However, the key to creating real competition lies in improving transparency. Despite the introduction of current account switching, it is still hard to generate genuine competition for deposits and payments services that customers typically view as a free public utility.

Despite the challenges and uncertainties, the number of new and potential new entrants highlights the continued attractiveness of UK banking.

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Banking highlights:

  • 2014 is expected to be a year of transition, with some banks expected to gradually rebuild their balance sheets. By 2016, assets should rise above £7t for the first time since 2011.
  • The improved economy should contribute to a revival in the mortgage market. We forecast the stock of mortgages to rise to £1.12t by the end of this year, 3% higher than that at the end of 2013.
  • Consumer credit is forecast to grow steadily over the next four years. We forecast write-off rates to fall to almost 2% by 2015, from a peak at 5.5% in 2010.
  • Business lending should pick up from 2014, rising 2.5%. However, at £417b, it will still be 27.5% below the 2008 peak.