EY ITEM Club Outlook for financial services - Minds made for empowering financial services
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EY ITEM Club
Outlook for
financial services
Minds made for empowering
financial services
Summer 2018
ey.com/fsitemclubey.com/fsitemclub About this report The EY ITEM Club: Outlook for financial services examines the implications of the EY ITEM Club’s economic projections for the financial services sector. EY is the sole sponsor of the EY ITEM Club, which is the only non-governmental economic forecasting group to use the HM Treasury model of the UK economy. Its forecasts are independent of any political, economic or business bias. In conjunction with ITEM’s Chief Economist Howard Archer, Oxford Economics is responsible for producing the forecasts and analysis provided in ITEM’s forecast reports. Oxford Economics is one of the world’s foremost independent providers of global economic research and consulting using unique global economic models. EY is a leader in shaping the financial services industry We are a global leader in assurance, tax, transaction and advisory services. Over 30,000 of our people are dedicated to financial services, serving the banking and capital markets, insurance, and wealth and asset management sectors. At EY Financial Services, we share a single focus — to build a better financial services industry, not just for now, but for the future. Together let’s build a better working world. ey.com/fsminds 2 | EY ITEM Club Outlook Summer 2018
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Contents
04 06
Macroeconomic overview Banking
08 10
Insurance Wealth & Asset Management
EY ITEM Club Outlook Summer 2018 | 3ey.com/fsitemclub
Macroeconomic overview
A weakening economic outlook Consumers face a renewed squeeze
presents a challenge to financial on disposable income and spending…
services firms Inflation continues to decline, falling to 2.4% in
April and May from a peak of 3.1% last November.
The first quarter of 2018 saw an expansion of just 0.2%
But unfortunately, the next few months are likely to
in the UK’s gross domestic product (GDP), one of the
see a renewed squeeze on households’ spending power
weakest results in over five years. Growth may have
as oil reached a 3.5-year peak of $80 per barrel in
been affected by the severe winter weather, but we
May, and higher energy prices will take effect over the
have seen few convincing signs of a strong rebound
summer. On the upside, record levels of employment
since. Several factors, including slowing Eurozone
should provide support for consumption. Set against
growth and rising oil prices, mean that this forecast
that, sluggish wage growth means that real household
is less encouraging than the spring edition six months
disposable incomes will grow by just 1.3% this year
ago. We now expect GDP to grow by 1.4% this year.
and next. The household saving ratio also reached a
This is down from our previous prediction of 1.7% and
50-year low in 2017.
well below historic trends and current global averages.
That sluggish performance will make it difficult for The resulting need to rebuild household savings means
financial services companies to grow and support the that consumer spending is only expected to grow by
economy as much as they would like. 1.2% this year and 1.5% in 2019.
1.4% 2.4% 2.4%
GDP Inflation Mortgage lending
We now expect GDP to grow by 1.4% this Inflation continues to decline, falling to Mortgage lending will climb 2.4% this year
year. This is down from our previous 2.4% in April and May from a peak of and experience its weakest growth since
prediction of 1.7% and well below historic 3.1% last November. 2013 next year, 1.8%.
trends and current global averages.
4 | EY ITEM Club Outlook Summer 2018ey.com/fsitemclub
…whilst cooling global growth and We now expect the Bank of England
Brexit uncertainties raise questions to raise the interest rate only once
over exports and investment this year
In 2017, the weak pound and buoyant worldwide growth The Monetary Policy Committee’s focus on Q2’s
allowed net trade to make a sizable contribution to GDP. rebound in consumer spending suggests that a further
But whilst the US economy remains strong, the outlook hike in the Bank Rate could be looming. We expect a 25
for exports is increasingly clouded by growing global basis point rise to 0.75% in August, although weak pay
protectionism and slowing growth in the Eurozone – growth and Brexit uncertainty could delay that decision
the UK’s biggest export market. until November.
Our forecast assumes that Brexit uncertainty will
ease this year as the UK and EU move toward an
agreement on withdrawal and transition. That would
push up sterling but should reduce headwinds to inward
investment. However, there are clear downside risks
to this scenario. Political friction in the UK and the slow
pace of negotiations mean that a “no-deal Brexit” can’t
be ruled out. The resulting fall in sterling might provide
a short-term boost to exports, but such an outcome
could have serious negative implications for the
economy and the financial services sector in particular.
4.7% 4.1% 1.2%
Business lending Consumer credit Consumer spending
We forecast a 4.7% expansion in the stock We expect consumer credit growth to Consumer spending is set to climb by just
of business lending this year, with further slow to 4.1% and 1.9% this year and next. 1.2% this year – the lowest rate since 2011.
growth of 2.5% in 2019
EY ITEM Club Outlook Summer 2018 | 5ey.com/fsitemclub
Banking
Dampened household incomes Despite this, we expect consumer credit growth to slow
to 4.1% and 1.9% this year and next. This dramatic shift
will hold back demand for lending in momentum reflects a combination of demand- and
this year supply-side pressures. On the demand side, we forecast
The next two years will see real household incomes consumer spending to climb by just 1.2% this year –
limited by still-high inflation and slow employment the lowest rate since 2011. Households need to bring
growth. This will keep a lid on household lending growth. their spending levels back in line with real incomes,
Meanwhile, businesses’ preference for nonbank finance especially in the light of 2017’s record low household
will continue, although it should weaken slightly this savings ratio of 4.1%. Meanwhile, the Bank of England’s
year. These factors mean that banks’ total lending is Credit Conditions Survey for the first quarter of 2018
now expected to grow by just 1.7% this year and 1.5% shows that a net balance of nearly 40% of lenders
in 2019. expect the supply of credit to tighten. The first quarter
also saw a year-on-year fall from 30 to 26 months for
Household debt stabilises, whilst interest burden average interest-free credit card transfer periods.
falls to a new record low
% %
The outlook for business credit
170 14
160
12
150
10
looks modest, despite banks’
willingness to lend
140
130 8
120 6
Growth in business lending remains relatively soft,
110
100
4 following a contraction of 4.3% in the stock of business
90
2 loans during 2017. The year to April saw modest
80 0 lending growth of 2%, but if repayments are taken
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
into account, the stock of loans only increased by
Debt as % of income (LHS) Interest payments as % of income (RHS)
1% over that period. This may seem odd, given solid
Source: EY ITEM Club corporate profitability and the 6.2% expansion in
total UK corporate debt during 2017. The uncertain
The mortgage market is particularly investment outlook is one factor, but the leading
subdued… consideration is the continuing popularity of nonbank
finance. Investors’ thirst for yield is generating
The past few months have been quiet ones for the sustained demand for UK corporate bonds, with
housing market. This reflects pressure on real incomes, nearly three-quarters of net corporate borrowing
stretched affordability and expectations of higher since 2007 coming via securities issuance.
interest rates. As a result, mortgage lending grew by
just 3.4% in the year to April 2018, around a third of However, a 30 basis point increase in investment grade
the 1997–2006 average. We expect this stable but sterling corporate bond spreads since early 2018
sluggish picture to continue, with net mortgage lending suggests that banks could have a fresh opportunity to
climbing 2.4% this year and 1.8% in 2019 – the slowest increase their lending, including to SMEs. We forecast
pace since 2013. Mortgage rates remain near historic a 4.7% expansion in the stock of business lending this
lows, despite last November’s Bank Rate hike. But even year, with further growth of 2.5% in 2019.
with house prices growing slowly, the ratio of prices to
A soft outlook for lending growth
average earnings remains high. According to Halifax,
% year
this was 5.6 in May, well above the 35-year average
25
of 4.2. Forecast
20
15
…and although consumer credit
10
5
keeps growing, it too will begin to 0
cool this year -5
-10
Consumer credit growth has exceeded our predictions, -15
2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
growing by 8.8% in the year to April 2018. This is slightly
Consumer credit Lending to companies Mortgage lending
lower than November’s peak of 10.9%, but that is largely
due to weaker car financing, a market where most banks Source: EY ITEM Club/Haver Analytics
are largely inactive. Personal lending and credit card
debt continue to expand, recording growth of 8.7% and
8.9%, respectively, during April.
6 | EY ITEM Club Outlook Summer 2018ey.com/fsitemclub
Banks face new funding pressures Meanwhile, the implications of last year’s Plevin ruling
on compensation for mis-sold payment protection
and a fresh surge in PPI costs insurance may be behind rising compensation costs in
The end of the Bank of England’s Term Funding the run-up to the August 2019 deadline for claims. The
Scheme, which provided cheap financing to commercial six months to March 2018 saw monthly compensation
banks, in February means that banks may have to average £376m, 60% up on the £233m averaged in the
compete more aggressively for customer deposits. same period in 2016–17. This pushed up the cumulative
With competition making it harder to charge borrowers cost since 2011 to almost £31b. And the recent legal
more and the average interest rate on new deposits ruling on commission thresholds could, if it creates
higher than the Bank of England rate, the loss of cheap a precedent, result in a significant hike in the total
funding may weigh on banks’ profit margins, although compensation bill.
the option of tapping the securitisation market could
reduce upward pressure on costs. Moreover, the
potential for increased transparency resulting from the
FCA’s review into retail banking business models could,
in the long run, reduce the income of some banks by
encouraging depositors to switch providers.
Banking sector recap
2016 2017 2018 2019 2020 2021
Total assets (£b) 6,995 7,332 7,460 7,501 7,666 7,903
Total loans (£b) 6,077 6,372 6,566 6,666 6,826 7,042
Business/corporate loans (£b) 407 390 402 416 425 437
Write-offs (% loans) 0.5 0.3 0.4 0.6 1.0 1.1
Consumer credit (£b) 193 207 216 218 225 233
Write-offs (% loans) 1.6 1.3 1.3 1.5 1.7 2.1
Residential mortgage loans (£b) 1,155 1,205 1,234 1,256 1,292 1,329
Write-offs (% loans) 0.01 0.01 0.01 0.02 0.03 0.04
Deposits (% year) 8.2 -0.8 2.6 0.5 1.2 3.2
Loans/deposits (%) 134 142 142 144 145 145
Total income (£b) 134 136 137 139 143 149
Source: EY ITEM Club
EY ITEM Club Outlook Summer 2018 | 7ey.com/fsitemclub
Insurance
Modest growth in real incomes …and home insurance markets
is welcome but will give limited remain tepid
support to non-life premiums The sluggish home insurance market is another
Following a dismal 2017, when average inflation- contributor to slow non-life growth. Stretched
adjusted incomes fell by 0.6%, 2018 holds slightly affordability for potential buyers and a limited supply
more encouraging news for big-ticket spending and of properties coming to market mean that we expect
non-life premium growth. Unfortunately, we expect housing transactions to rise by little more than 1%
higher petrol prices and utility bills to weigh on a year from 2018 to 2021. For comparison, annual
household finances, limiting real income growth to transaction growth averaged 5.9% over the previous
1.3%. That is a long way off the 3.1% average annual five years.
increase seen between 1997 and 2007. This weak
Housing transactions are forecast to see only
performance means that non-life premium growth
modest growth
will be limited to 3.2% this year and 3.1% in 2019.
000s
Motor insurance prices have started to fall 450 Forecast
% year
400
20
15 350
10
300
5
0 250
-5
200
-10 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
-15
2010 2011 2012 2013 2014 2015 2016 2017 Source: EY ITEM Club/Haver Analytics
Home contents CPI inflation Motor insurance
Source: EY ITEM Club/ONS
Prospects for asset markets are
becoming less favourable to life
companies
Motor insurance faces a mixed
The softening global growth outlook, illustrated
outlook… by the Eurozone slowdown and the rising risks of
Motor insurance faces some specific head winds. protectionism, suggests that the performance of
The most obvious is the continuing plunge in sales equity markets this year will not replicate that of
of new diesel vehicles. Slowing growth in Personal 2017. And although bond yields should climb as the
Contract Purchases is another cooling factor, together Bank of England raises rates, life insurers won’t escape
with signs of a gradual shift away from car ownership. the pressures of a low-rate world for some time.
Car registrations are forecast to fall by 4.2% this year, UK yields remain surprisingly weak, compared with
following 2017’s drop of 5.7%. We only expect to see US equivalents, and we anticipate just one 25 basis
modest growth of 1% in 2019. point UK rate rise this year, with two more in 2019.
On the face of it, a 3.5% fall in motor pricing during the As the world moves toward monetary tightening,
year to May is further bad news for insurers. This was we expect the 10-year gilt yield to average 2.6%
the second consecutive decline and contrasts with the between 2018 and 2021. In comparison, 10-year
11% rise recorded in May 2017. However, lower prices gilts were yielding just under 1.3% at the start of July,
do not necessarily indicate a turn in the rates cycle. down from a recent peak of 1.6% in April. We forecast
Reforms to the Ogden discount rate have so far had life premiums to rise by an annual average of 3.4%
a softer impact than expected. between 2018 and 2021.
8 | EY ITEM Club Outlook Summer 2018ey.com/fsitemclub
Demographic changes could provide The recent Retirement Outcomes Review made it
clear that providers should expect ongoing change,
some support for profits… starting with the launch of a consultation on consumer
Overall, we forecast insurance profits to grow by an protection and competition in the retirement income
average of around 6% over the next few years, driven market. The ongoing review into Defined Benefit to
in part by increasing bond yields and improving claims Defined Contribution transfers is likely to put in place
ratios. The fact that the ONS sees UK life expectancy more stringent controls on transfers into personal
gains as having tailed off since 2011 is troubling but pensions or drawdown products, dampening the
could boost profits by enabling insurers to adjust their market.
mortality assumptions. In time, this trend could also
Finally, 2018 has seen the first planned rise in auto-
reduce corporate pension scheme deficits, encouraging
enrollment contribution rates, without significant
buyouts by specialist insurers.
impact on opt-out rates. If 2019’s larger rise also
goes through smoothly, new money into pension
…though the impact of policy schemes should see a significant boost.
changes remains unclear
Looking ahead, policy changes will continue to affect
the life sector. The introduction of “pension freedoms”
led to over 1.5 million personal pension pots being
accessed between April 2015 and September 2017.
That marks a substantial shift toward drawdown and
away from annuities. The FCA continues to focus on
safeguarding customer outcomes.
Insurance sector recap
2016 2017 2018 2019 2020 2021
Life gross premium (£b) 163.1 166.4 170.2 173.5 179.2 188.0
% year 1.0 2.0 2.3 1.9 3.3 4.9
Life gross claims payments (£b) 122.0 123.5 123.0 122.1 122.7 125.0
Life claims ratio (%) 75 74 72 70 68 66
Non-life gross premium (£b) 57.3 59.1 61.0 62.9 65.0 67.5
% year -2.8 3.2 3.2 3.1 3.4 3.8
Non-life gross claims payments (£b) 31.3 33.4 34.0 34.6 35.2 36.0
Non-life claims ratio (%) 55 57 56 55 54 53
Net profit (£b) 6.1 7.9 8.5 8.9 9.4 10.0
Source: ITEM, OECD, Swiss Re
EY ITEM Club Outlook Summer 2018 | 9ey.com/fsitemclub
Wealth & Asset Management
2017 delivered the strongest rise in …but cloudier global prospects
AUMs since 2010… suggest less strength ahead
2017 saw the FTSE 100 Index record a rise of 14.7%, Unfortunately, this strength is unlikely to be repeated
its biggest since the start of the decade. This, together in 2018. Sterling’s retreat against the dollar in recent
with buoyant global markets and a further weakening months will support UK equities, many of which have
in sterling, helped UK assets under management (AUM) significant foreign earnings. However, we forecast the
rise by 17.4% during the year. That was the strongest pound to stage a modest recovery over the coming
growth since 2010 and the second year running of year. This reflects a gradual rise in UK base rates
double-digit expansion. At the end of 2017, AUM – expected to start in August – and our hopes for a
reached almost £1.3t, equivalent to 62.4% of UK GDP. gradual reduction in Brexit-related uncertainty.
As recently as 2016, that figure was less than £1t. If proved correct, that would reduce the mechanical
boost to equities from sterling’s weakness.
Strong AUM growth in 2016/17 is forecast to cool
A more mixed outlook for the world economy also
£b
90
suggests that global asset prices will perform less
AUMs (£b) Forecast
well than we previously forecasted. The US economy
80 GDP (£b)
70
continues to perform strongly, but the Eurozone has
60
struggled to rebound from its slowdown in early 2018,
50
and the growing risks of a global trade war are already
40
dampening asset valuations. It’s worth noting that
30
there are few signs of over-valuation; the FTSE’s price-
20
earnings ratio at the end of June was 13.6, well below
10
the 15-year average of almost 16. Even so, a projected
0
average annual rise of 4.8% in the FTSE All Share Index
2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
between 2018 and 2021 is less than half the figure
Source: EY ITEM Club/Haver Analytics achieved in 2016 and 2017. So whilst we expect some
capital to shift from bonds to equities, the extent
of the rotation will be modest – limiting the sector’s
profitability growth.
10 | EY ITEM Club Outlook Summer 2018ey.com/fsitemclub
Auto-enrollment and high High levels of UK employment will bolster inflows from
auto-enrollment, and we expect AUM to receive a boost
employment offer some potential as households face up to rebuilding saving ratios from
opportunities 2017’s record low levels. Set against that, a slowdown
On the upside, the asset and wealth management in the growth of households’ financial assets could
sector is well-positioned domestically to benefit create head winds to inflows. The level of UK household
from increasing mandatory saving. April 2018 saw wealth is already high by historical standards. Net of
employers’ auto-enrollment pension contributions financial liabilities, it equated to 352% of household
by employees rise from 1% to 2%, with a further incomes in the first quarter of 2018, compared with
increase to 3% planned for April 2019. The DWP now an average of 282% since 1988. Household financial
expects auto-enrollment to add £19.7b per year to assets grew at just 3% in the first quarter of 2018,
pension savings by 2019–20, equivalent to around 1% down from 11.2% in the third quarter of 2016 and
of UK GDP. Although some savers might opt out as following a rare decrease of 1.2% in the final quarter
contribution rates rise, inertia suggests that most are of the same year.
unlikely to do so without a triggering event such as a
job change.
AUMs forecast sees shift towards equities
£b
1750
Money market Mixed Forecast
1500 Fund of funds Equities
Property Bonds
1250
1000
750
500
250
0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021
Source: EY ITEM Club/Broadridge
Wealth & Asset Management sector recap
2016 2017 2018 2019 2020 2021
Total Assets under management (£b)* 1,086 1,275 1,302 1,327 1,399 1,498
% year 16.5 17.4 2.1 1.9 5.4 7.1
Bonds (£b) 165 187 186 186 188 190
Equity (£b) 539 647 670 684 727 784
Fund of Funds (£b) 133 158 160 163 172 189
Hedge (£b) 1.3 1.3 1.3 1.3 1.3 1.3
Mixed (£b) 159 180 182 188 205 224
Money Market (£b) 59 68 69 70 72 73
Property (£b) 28 34 33 33 35 36
*UCITS and non-UCITS assets
Source: EY ITEM Club, Broadridge
EY ITEM Club Outlook Summer 2018 | 11EY | Assurance | Tax | Transactions | Advisory About Oxford Economics
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