Why current challenges make a more sustainable financial future crucial

Subject to a successful vaccine roll-out, the EY ITEM Club forecast shows a more positive economic outlook in 2021 for financial services

As we enter the second month of the UK’s third national lockdown, it was with some apprehension that I started to read our most recent – and my first - EY ITEM Club Outlook for financial services (PDF, 9MB). The forecast is predicated on a successful initial vaccine rollout followed by a subsequent relaxation of lockdown restrictions and, despite promising progress, whether the vaccine targets are met, how long current lockdown restrictions will last, and in what form they will be eased, are all unknowns that have downside risks. In addition, new virus variants add further layers of uncertainty and challenge to the mix.

However, if these unknowns unfold positively, the EY ITEM Club believes that the UK economy will narrowly miss a second recession and will rebound in the second half of the year, with Gross Domestic Product (GDP) rising 5% in 2021. This is good news, and a stark contrast to the 10.1% fall in 2020, but it should not be misinterpreted; it’s a welcome improvement on a still very challenged economy. 

Improved conditions, but financial services firms still face short-term challenges

For financial services firms the outlook is also improved but, as noted, the risks remain predominantly to the downside. The sector is heavily supporting UK businesses through this challenging time, and business lending growth in particular is expected to remain historically high through 2021, although slowing from 2020’s rate of expansion. Total business lending – including Government-backed loans - rose by 8% in 2020 and is forecast to grow by a further 5.4% this year, equating to £26b net being lent to firms on top of the £35.5b last year. To view this in a broader context, the average growth rate between 2015-2019 was 2.8%, evidencing that current borrowing for many is about survival, not growth or innovation. But as the economy recovers, and firms bounce back, banks must be poised to fuel growth.

Looking at household borrowing, although consumer credit is expected to increase 2.1% this year, this is a modest rise, reflecting continued consumer caution and the prospect of heightened unemployment as the Job Retention Scheme ends in April. Meanwhile, a tightening of lending conditions for high loan-to-value (LTV) mortgages and the stamp duty holiday ending in April means the mortgage market is showing signs of cooling off, despite ending 2020 on a strong note. Slower growth in overall lending and pressure on net interest margins from low interest rates will both impact banks’ profitability. Profits will be even further challenged when Government-backed business lending schemes draw to a close and credit losses rise, although with household savings at an all-time high, spending is expected to surge once lockdown restrictions appreciably ease. Whilst this is a difficult environment to operate in, banks entered the pandemic well capitalised, and are positioned to weather the storm. 

The insurance sector also continues to feel the severe financial impacts of the pandemic. COVID-19 related insurance pay-outs present ongoing challenges for growth and continued low interest rates are impacting profitability. Although for motor insurers, claims have fallen significantly with reduced traffic and fewer accidents. Outside of the pandemic, the sector is also contending with the devastating effects of flooding across the UK. How insurers manage these challenges will be crucial for thousands of people and, managed well, could meaningfully boost customer trust. On the asset management side, the outlook is relatively positive, following the global market recovery in H2 2020. UK assets under management (AUM) are projected to grow 7.1% in 2021, up on 2020’s 3.6% growth (despite the economic turmoil), although down on 2019’s 11.6% gain. 

Longer-term, the UK economic outlook is poised for revived growth

The longer-term forecast – based on the economy opening up from this spring – heralds a strong recovery in GDP, with 5% and 6.5% growth forecast in 2021 and 2022 respectively. Consumer spending is expected to rebound by 5.1% in 2021 and 7.4% in 2022 as social distancing restrictions are relaxed, representing a significant recovery on 2020’s dramatic fall. And, following a strong performance last year, UK equity prices look well-primed for further growth and may even outperform their international peers. All of this is welcome news for financial services firms as it reduces the risk of further write-offs on loans and provides a boost via higher consumer spending.

However, amid future growth predictions, there is a big, structural question yet to be answered. How will consumer and business behaviour change as a result of the pandemic? This is the second major global economic shock in recent times, and it could also have a fundamental ripple effect on spending behaviours and risk appetites.

Sustainability, digital innovation and strong governance crucial for a post-pandemic financial services future

Outside of the pandemic, there remain a multitude of other challenges for financial services firms to contend with. Brexit uncertainty still prevails as firms await further clarity on equivalence and the framework for regulatory cooperation. And further ahead, as the economy looks to a recovery, firms will be keen to engage with Government on how the UK proposes to achieve the ambitious green and digital targets set out in 2020. 

Right now, the industry is focused on supporting the UK economy through these challenging times. But as we look ahead and forge a new path outside the EU, the current health and climate challenges only make a more sustainable financial future, underpinned by digital innovation and strong governance, ever more important, and UK financial services are uniquely positioned to take a leading role, at home and abroad.