6 minute read 17 Feb 2020

Why Brexit is no longer the greatest challenge for financial services

By

Omar Ali

EY UK Financial Services Managing Partner

UK financial services leader. Passionate about making UKFS a great place to work where people can reach their potential. Champion for D&I. Football enthusiast. Bad at skiing.

6 minute read 17 Feb 2020

Clarity on Brexit boosts sentiment, but structural changes and emerging trends are impacting growth opportunities for financial services.

Although little time has passed since the last EY ITEM Club Outlook for financial services, much has changed in the political environment. Last December’s General Election ended with a conclusive result and the UK had an orderly exit from the EU at the end of January. 

These developments have given UK businesses and consumers some much-needed short-term clarity, which is expected to lead to a slight boost in economic activity. The forecast for gross domestic product (GDP) growth is now 1.2% for 2020, picking up to 1.7% in 2021 - an improvement from the 1% and 1.5% growth we previously forecast. This should result in a small increase in demand and opportunities for financial services to support households and businesses.

How far these early green shoots translate into a more sustained improvement depends on several factors. In particular, the Government’s commitment to end the post-Brexit transition period at the end of this year, regardless of whether a deal has been agreed, means that the shape of future trade deals and immigration laws remain unknown.

Long-term business confidence will depend on the outcome of these negotiations but, in the short-term, consumer confidence is set to have the biggest impact on the economy and the outlook for financial services firms.

There are many positive signs for consumers in the latest forecast; interest rates are unlikely to rise from 0.75%; real income is expected to grow 1.8% this year, up from 1.1% in 2019; mortgage interest rates remain close to a record low, and banks have shown more willingness to lend at high loan-to-value (LTV) rates. Additionally, unemployment is forecast to remain at a historically low rate, with employment forecast to hover around a record high.

Looking at all these elements together, we would expect to see an increase in confidence and sentiment and a resulting boost in consumer spending and investment.

However, the forecast for consumer credit growth this year is 3.2% - the lowest in six years - and isn’t expected to significantly increase in the next few years. And overall mortgage lending growth is forecast to rise only 4.1% this year, close to the average of the last five years. For financial services, this represents modest growth and so the resulting competition for consumers’ business means rates, and therefore profits, will be suppressed.

Consumer credit growth in 2020

3.2%

The consumer credit growth forecast in 2020 is the lowest in six years

The question for firms to grapple with is, how much of this is down to confidence and how much is down to structural changes in consumer behaviour?

One indicator of increased consumer confidence is a rise in the proportion of household wealth held in investments, rather than currency and bank deposits, which suggests consumers may be more willing to take investment risks.

Consumer confidence is therefore improving, but behaviour which drives demand for traditional products and services is changing.

Looking at two key drivers of consumer borrowing, we can see longer-term fundamental changes at play. The motor sector is continuing to face several structural shifts including a declining demand for diesel vehicles and the growing use of ride sharing services. In addition, we know that environmental and sustainability concerns are also deterring consumers from buying a car. Motor finance accounts for around a third of the stock of consumer credit, and so the impact of these changing consumer behaviours on potential growth should not be underestimated.

In the housing sector, low mortgage rates and accommodative LTV ratios should be driving growth but affordability remains the key challenge. In Q3 2019, the average house price was equal to 4.7 times the average borrower’s income, close to a record high. Although wages are forecast to rise by an average of 3.5% over the next few years, house prices are forecast to grow at a similar pace, meaning that the challenge of affordability is not going away anytime soon. 

The story for businesses is different. Business investment, and resultant business lending, continues to be weak. Brexit-related uncertainty has contributed to subdued growth in business lending, which has averaged a modest 4% since 2016. This year, businesses face new uncertainty over whether the UK and EU will arrive at a trade deal before the end of the transition period, and under what terms. The new Government’s commitment to infrastructure spending will buoy confidence but the risks businesses are now facing extend beyond Brexit and the UK; the impact of climate change, global geopolitical uncertainty and the (as yet unknown) economic impact of the coronavirus, will be weighing on their minds as they consider whether and where to invest. As a result of these pressures, and continued competition from “non-bank” finance, the EY ITEM Club forecasts muted business lending growth of 3.4% in 2020. 

A good Brexit outcome will continue to lay positive foundations for future growth, but there are deeper, structural changes to consumer behaviour and important emerging trends in both consumer and business finance which the industry needs to tackle.

In this context, financial services need to reconsider the role they will play in helping their business customers to navigate change. They have put the customer first in their response to Brexit and now need to do the same on climate change, trade and geopolitical unrest. Those firms that do this well will be in the best position to compete with “non-bank” sources of finance and to continue to attract new customers.

Key findings

  • Consumer credit growth is forecast at 3.2% for 2020, the lowest in six years, down from 3.7% in 2019
  • Overall mortgage lending growth is only forecast to rise 4.1% this year, close to the average of the last five years
  • Bank business lending is forecast to grow at a subdued 3.4% this year, as investment grows only modestly, and firms continue to look at alternative forms of finance

For the full findings, download our forecast

Read the press release

A good Brexit outcome will continue to lay positive foundations for future growth, but there are structural changes to consumer behaviour and important emerging trends which the industry needs to tackle
Omar Ali
EY UK Financial Services Managing Partner

Summary

Although the outlook for the UK economy has improved slightly over the last three months – giving a short-term boost to sentiment and activity – a multitude of factors are impacting economic growth and the associated opportunities for financial services firms.

About this article

By

Omar Ali

EY UK Financial Services Managing Partner

UK financial services leader. Passionate about making UKFS a great place to work where people can reach their potential. Champion for D&I. Football enthusiast. Bad at skiing.