EY ITEM Club

Outlook for financial services
Winter 2016-17

Banking & Capital Markets forecast

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Meeting uncertainty head on

Whilst Brexit remains a key challenge in the near distance, the economic outlook is better than expected in our last forecast. That said, exiting the single market is still set to cause a softening in the economy and slow the demand for credit, whilst the continued uncertainty over the exact nature of our future trading relationship with the EU will also weigh on the sector.

However, banks’ strong performance in 2016 provides them with a solid base to face these challenges.

 
Robert Cubbage
Partner, UK Banking & Capital Markets Leader, EY UK
Read Robert’s full forecast viewpoint

Meeting uncertainty head on


EY - Robert Cubbage
Robert Cubbage
Partner,
UK Banking
& Capital
Markets Leader,
EY UK

Whilst Brexit remains a key challenge in the near distance, the economic outlook is better than expected in our last forecast. That said, exiting the single market is still set to cause a softening in the economy and slow the demand for credit, whilst the continued uncertainty over the exact nature of our future trading relationship with the EU will also weigh on the sector.

However, banks’ strong performance in 2016 provides them with a solid base to face these challenges. ↓ [... more]

Monetary policy changes prove a double-edged sword...

The Bank of England’s actions to alleviate the shock of the referendum result have been helpful for the economy, and combined with resilient consumer demand, helped support growth of 12.6% in total lending from UK banks in 2016, compared to 2015. August’s cut in the Bank rate to 0.25% led to record low mortgage rates, whilst cheap funding through the Term Funding Scheme is incentivising lending, and will do so to its conclusion in February 2018.

However, the impact has not been universally positive. The Bank’s move to buy corporate bonds has reduced demand for business loans as firms make more use of bond finance. Compounded by the prospect of declining investment spend, the growth rate of bank lending to firms will halve this year, and flatline in 2018. Banks’ business lending will reach £414b in 2017, up from £406b in 2016, and will eventually climb to £419b in 2019.

…as rising long-term interest rates bring respite for banks

Low interest rates also bring with them a drag on banks’ profitability, so there will no doubt be a sense of relief when the Bank rate finally rises, which is anticipated in mid-2018. In the meantime, the recent rise of global long-term rates is welcome news. In the UK alone, UK 10-year government bond yields have now more than doubled to 1.3% since August, and should average 2.6% over the next four years. This should provide some support for profits in the year ahead if banks are able to increase the gap between deposit and savings rates.

Clarifying the impacts of Brexit will stay front of mind…

As we prepare to exit the single market, we may see costs rise for UK banks that wish to continue serving EU customers. An implementation period, mooted by Theresa May, would allow affected banks to avoid a regulatory cliff edge, whilst many are already taking tactical decisions that will enable them to protect cross-border operations.

…but banks should also keep an eye on the political changes elsewhere

In the US, President Trump’s more moderate approach to regulation of the banking industry includes proposed measures to reduce the scope of the Dodd Frank Act. A repeal of Volker is unlikely to trigger a rush back into proprietary trading, however, the subsequent reduction in regulatory administration and costs will certainly create a positive effect for banks with operations on both sides of the Atlantic.

The current uncertainty about the new US President’s economic plans may herald a period of market volatility and a sense of unpredictability about the economic outlook over the next few months. Safe haven assets may provide some protection against exchange rate fluctuations and the possibility of further weakening of sterling and UK inflation, if the US economy strengthens.

Even so, the outlook brightens as banks take action

Despite the political climate, a stronger economy has helped to brighten the outlook for the banking sector. But banks have also taken action to secure their future.

Capital positions are improving, as the Bank of England’s stress tests in December attest. There may be further pressure to build capital buffers when the terms of ‘Basel IV’ are agreed, but UK institutions would be well placed to meet requirements compared to some of their international peers. Asset quality has also improved, with a reduced ratio of non-performing loans.

At the same time, banks are investing in long-term business model transformation. The initial focus on revitalising front-office technology has now moved towards the mid and back office, as banks look to digitalise processes, and improve efficiency. Regulation is acting as a catalyst for technological innovation too, for example, the advent of Open Banking. Collaboration between banks and third parties will continue as banks look to improve the experience of their customers.

The cost of transformation programmes has held back profits in the short term. But the benefits will begin to materialise over the medium term and should give UK banks a solid foundation to weather the political and economic headwinds.

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Highlights:

  • UK bank assets grew by 11% in 2016, the fastest rise since 2008. They will grow by a slower 1.5% this year, and shrink next year, before modest growth returns in 2019.
  • Growth in mortgage lending is set to slow to 1.4% this year, and just 0.1% in 2018, compared to 4.4% in 2016.
  • The stock of business loans will reach £414b in 2017, as growth slows to less than 2%, before stagnating in 2018.
  • Growth in consumer credit will slow, but still increase by 4% in 2017.