Total business volumes in the financial services sector fell slightly in the three months to December, marking the first contraction of demand since September 2013. That’s according to the latest CBI/PwC Financial Services Survey.

Meanwhile, sentiment among financial services deteriorated further, rounding off three full years of flat or falling optimism.

The quarterly survey of 84 firms reveals a marked divergence in business conditions between sub-sectors, with sentiment holding up among insurers amid a continued expansion in their business volumes. By contrast, volumes were flat or falling for banks, building societies and specialist lenders, while investment managers report the steepest fall in activity since the financial crisis.

Overall business volumes are expected to fall at a similar pace over the quarter to March, the first-time growth expectations have turned negative since December 2009. Financial services firms - particularly banks, building societies and general insurers - see macroeconomic uncertainty as the most important challenge over the year ahead, ahead of regulatory compliance and preparing for the impact of Brexit.

Profits in the financial services sector as a whole were remained flat for a third successive quarter, reflecting little change in business volumes and costs. Investment managers and general insurers reported declining profitability. In the three months to March, overall profitability is expected to fall for the first time in over three years, as a result of a more widespread deterioration in expectations across the industry.

Rain Newton-Smith, CBI Chief Economist, said:

“A combination of macroeconomic and Brexit uncertainty, regulatory compliance and global market volatility are taking a toll on the UK’s financial services sector. Financial services are a bellwether for the wider economy. The persistent weakness in optimism and the deterioration in expectations sound a warning for the outlook. 

“It’s clear the sector is grappling with a number of other challenges too, from using data to improve customer experiences, to new entrants to the sector. However, with new risks and demands come opportunities. Insurers in particular are pulling ahead, many of whom are moving into areas such as asset management outside of their traditional markets.” 

Andrew Kail, Head of Financial Services at PwC, said:

“Continued economic and political uncertainty means last year ended on a more pessimistic note than previous quarters for many working in UK financial services. It's a broad industry, meaning optimism varies between sub-sectors and companies, but this survey shows that investment managers, who have been more immediately impacted by volatile stock markets, are gloomiest heading in to 2019.

“The underlying reasons for this dip in optimism have been around for some time – political and Brexit-related uncertainty, regulatory pressures and a sustained low interest rate environment impacting margins. Competition from established peers as well as new market entrants is also high on companies' radars.

“UK financial services firms looking to prosper in 2019 should concentrate on issues they can control. Most importantly, by focusing on clear strategies for delivering value through products and services which meet their customers' needs, maximising the efficiency of delivering these services - keeping operating costs under control - and using technology to augment the quality and efficiency of activities across their business.”  

Despite this outlook, firms expect to increase headcount in the quarter to March and investment intentions for the year ahead remain broadly stable. Financial services firms plan to raise spending on marketing and IT at robust rates, and capital spending in other areas is expected to be unchanged. Firms indicated that efficiency and replacement were the main drivers of investment, alongside statutory legislation and regulation. 

Although growth in compliance spending continues to moderate, the regulatory environment is seen as the most important constraint on business expansion in the year ahead. Banks, insurance brokers and finance houses were most dissatisfied when asked whether regulators are keeping pace with digital innovations (such as digital documents, on-line platforms or apps) that could help support regulatory implementation and compliance. Common data standards/formats are seen as the most important digital innovation regulators could adopt in the next 18-24 months to help reduce the costs of regulatory implementation and compliance.

The more pessimistic outlook for the financial services sector in the near term is in keeping with the subdued prospects for the wider UK economy, with GDP growth expected to be held back by weak household income growth and the impact of Brexit uncertainty on investment. For more detail on our view of the economic outlook, see our December economic forecast.

Key findings:

• 24% of firms said that business volumes were up, while 32% said they were down, giving a balance of -7% (down from +12% in the quarter to September)
• Looking ahead to the quarter to March, business volumes are expected to be edge down further: 12% of firms expect volumes to rise next quarter, and 20% expect them to fall, giving a rounded balance of -9%, the weakest since December 2009 (-13%) 
• Optimism in the financial services sector continued falling in the quarter to December (-24%, compared to -30% last quarter), having declined in all but one quarter since the start of 2016.  

Incomes, costs and profits:

• Overall profitability was flat in the three months to December, with 24% of firms reporting that profits had increased and 20% saying they fell, giving a balance of +4% (following -1% in the previous quarter). Profits are expected to decline in the next three months (-14%)
• Income from fees, commissions and premiums fell (-17%) and is expected to fall further in the quarter ahead (-10%)
• Income from net interest, investment and trading was stable (-1%) and is expected to remain unchanged in the next three months (+1%)
• Total operating costs rose (+10%), but at a slower pace than last quarter (+17%), as did average costs (+6%, from +21% in September 2018). Both total costs and average costs are expected to rise more quickly next quarter (+23% and +15% respectively).

Employment:

• 14% of financial services firms said they had increased employment, while 9% said that headcount fell, giving a balance of +5%
• Numbers employed are expected to increase more rapidly (+21%) next quarter.

Investment over the next 12 months:

In the year ahead, financial services firms expect to increase spending on IT and marketing, and for other forms of capital spending to remain stable:

• IT: +65% (up from +49% in the quarter to September)
• Marketing: +31% (the same as in the quarter to September)
• Vehicles, plant and machinery: -2% (following -15% in September)
• Land and buildings: -2% (following -18% in September).

The main reasons for authorising investment are cited as:

• To increase efficiency/speed (70% of respondents)
• Statutory legislation and regulation (48%)
• For replacement (41%).

The main factors likely to limit investment are cited as:

• Inadequate net return (61% of respondents)
• Uncertainty about demand or business prospects (45%)
• Shortage of finance (20%).

Business expansion over the next 12 months:

The most significant potential constraints on business growth over the coming year are:

• Statutory legislation & regulation (49%)
• Level of demand (41% of respondents)
• Competition (39%).

Top three challenges for the year ahead:

• The most important challenge facing financial services firms over the year ahead is macroeconomic uncertainty (59% of maximum score achievable in a weighted ranking of challenges) 
• Regulatory compliance was also cited as an important challenge by many firms (26.7% of maximum score), alongside preparing for the impact of Brexit (25.3% of maximum score).

Satisfaction with digital innovation by regulators:

• 25% of firms said they were satisfied that regulators are keeping pace with digital innovations that could help support regulatory implementation and compliance. This compares with 28% saying they were dissatisfied
• Almost half (47%) of those expressing an opinion said they were neither satisfied nor dissatisfied with regulators’ digital innovations.

Most important digital innovations for regulators:

• 72% of firms said developing common data standards/formats were “essential” or a “high priority” for regulators in the next 18-24 months to help reduce the costs of regulatory implementation and compliance.