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Optimism in the financial services sector surged in the three months to September, as firms reported they were the most upbeat about their overall business situation for almost 17 years. That’s according to the latest CBI/PwC Financial Services Survey.

Infographic: More on the Financial Services Survey >>

Employment also grew, although at varying rates across different sub-sectors. But business
volumes fell unexpectedly, mainly in the banking sector.

The headline fall in volumes was driven by falling business with industrial and
commercial companies and overseas customers. Volumes were stable with private
individuals, which was disappointing given expectations of growth, while
business with financial institutions was the only area to grow.

Nevertheless, profitability rose for the fourth consecutive quarter, as companies managed to
offset the fall in business volumes by widening spreads. This reflected gains
in a majority of sub-sectors, including banking. Looking ahead, business
volumes are expected to recover strongly in the next quarter and, with costs
likely to fall, profitability is set to increase further.

Financial services firms also expect to add more jobs in the next three months, although
at a slower rate than in this quarter. Stronger demand, changing business
strategies and regulatory compliance were identified as major drivers of
recruitment.

Stephen Gifford, CBI Director of Economics, said:

“With optimism rising and jobs and profitability growing, this is an encouraging
quarter for the financial services sector, despite a fall in business volumes
in banking.

“Firmsare expecting positive momentum to carry into the next three months, alongside
a strong recovery in business volumes, which will boost profits further.  

“Financial services companies are less worried than they were about a potential lack of
demand, but dealing with regulation is increasingly weighing on plans for
business expansion.”

Commenting on the banking sector, Kevin Burrowes, PwC’s UK financial services leader said:

“Banks’ optimism is increasingly buoyant despite seeing a slight seasonal blip in
commercial and industrial volumes. Activity and profitability are expected to
grow as the economy recovers, and investment in new products and infrastructure
is increasing. A reduction in industrial and commercial business down to the
quiet summer was expected and is not an indication of a long-term trend.
Regulation continues to be the sector’s greatest source of uncertainty,
particularly as UK macroeconomic concerns start to fall away.

“We expect the full effect of the UK’s economic recovery to be reflected in bank
performance in the coming months, and their solid profitability is supported by
predicted cost reductions and increasing focus on growth." 

Companies plan to spend less on land & buildings and vehicles, plant & machinery
over the next twelve months. However, firms expect to spend more on IT, with
around two fifths of firms saying they would increase spending to combat
cybercrime. However, more than a third of respondents (38%) said a shortage of
finance was likely to limit capital expenditure, the highest level since
December 2008 (41%).

The level of demand has lessened as a constraint on business expansion in the year
ahead, falling to its lowest level since 2008 (60%). But statutory legislation
and regulation continues to be a burden on financial services companies, with
almost three quarters (71%) citing it as a likely brake on their business – the
highest proportion since March 2011 (76%). More than half of firms said that
dealing with the new twin regulators (the Prudential Regulatory Authority and
the Financial Conduct Authority) had already contributed to an increase in
costs.

Key findings:

• 59% of financial services firms said they felt more optimistic about the overall
  business situation in the sector, while 6% said they were less optimistic,
  giving a balance of +53% - the highest since December 1996 (61%)
• 22% of firms said business volumes were up, 32% said they were down, giving a
  balance of -10%
• Business with industrial and commercial companies was down (-18%), likewise with overseas
  customers (-18%). Business increased with financial institutions (+13%) and was
  flat with private individuals (+1%)
• Looking ahead to next quarter, 51% expect business volumes to increase, while 4% think
  they will decrease, giving a balance of +47%.

Incomes, costs and profits:

• Income from fees, commissions or premiums decreased in the three months to September
  (-23%), for the first time in a year. However, net interest, investment or
  trading income increased slightly (+5%), albeit disappointing expectations of
  somewhat faster growth (+17%)
• Average spreads widened considerably (+37%) – the fastest pace since June 2012 (+37%)
• Total operating costs rose marginally (+7%), while average operating costs fell (-9%)
• As a result of widening spreads and contained costs growth, profits continued to
  increase (+26%) and are expected to grow even more strongly next quarter
  (+35%),  as business volumes are set to pick up.

Employment:

• Numbers employed in the financial services sector increased in the three months to September
  (+24%) – the fastest rise since September 2007 (+25%)
• Employment is expected to increase again next quarter (+14%)
• Based on the latest survey figures on employment, and their historical relationship
  with ONS workforce jobs data, we expect financial services jobs to rise by
  10,000 in Q3 2013, and then by a further 2,000 in Q4. This will bring the level
  of financial services jobs to 1.14 million in Q4.

The next 12 months:

• Firms plan to spend more on IT over the next 12 months (+53%) but less on land &
  buildings (-24%) and vehicles, plant & machinery (-12%)
• shortage of finance is likely to limit capital expenditure over the next twelve
  months (38%), to the greatest extent since December 2008 (41%)
• The proportion of companies citing level of demand as a factor likely to limit
  business during the next year fell (63% from 84% last quarter) to its lowest
  level since September 2008 (60%)
• However, the number of firms citing statutory legislation and regulation as factors
  likely to limit business expansion rose from 59% last quarter to 71% - the
  highest level since March 2011 (76%)
• More  than half of firms (58%) said dealing with two regulators – the Prudential
  Regulatory Authority and the Financial Conduct Authority – had contributed to
  an increase in regulatory costs.

Analysis by sector:

Banking

Banks are very upbeat, with optimism rising rapidly, despite a fall in business
volumes over the past three months. A widening of spreads underpinned a solid
increase in profits. An expected return to volume growth, combined with falling
costs and another rise in spreads are expected to drive profits even higher
next quarter. In the year ahead, investment in IT is predicted to increase
strongly relative to last year, driven by a desire to improve efficiency. The
most widely cited barrier to growth was regulation. 

Building societies

Sentiment among building societies continued to rise and they reported a seventh
consecutive quarter of growth in business. Profitability rose at its fastest
since December 2010, while employment continued to grow. Business volumes are
expected to rise strongly again in the coming quarter, and employment to grow
further, albeit at a slower pace. Concerns about future demand restricting
business expansion have diminished, but building societies are more wary of
stronger competition.

Finance houses

Business was flat for finance houses, with only a marginal increase in profits reported
in the three months to September. Modest growth in volumes and profitability is
predicted for the next quarter. Headcount continued to expand, though slowed a
little. Investment in IT is expected to strengthen in the year ahead, but
investment intentions in other areas have become more negative as uncertainty
over demand grows. Inadequate net returns have also risen noticeably as a
constraint on capital spending, with this quarter’s citations the highest since
March 2012.

Life insurance

Sentiment among life insurers rose for the first time in three quarters. Business volumes
rose rapidly over the past three months, after declining for two quarters,
although the level of business was still judged to be below normal. With
pricing power squeezed, profits fell, but life insurers expect a return to
growth in profits next quarter, supported by predictions of growing premium and
investment income. Headcount increased and is expected to rise further.
Recruitment is being driven by two key factors: regulation and strategic
change.

General insurance

General insurers were mildly more optimistic than the previous quarter, with business
volumes showing a second successive quarter of growth in the three months to
September, and profitability rising at its fastest pace since March 2008,
boosted by higher fee & premium income and a fall in costs. Robust growth
in business volumes is expected during the next quarter.

Insurance brokers

Optimism among insurance brokers rose slightly. Business volumes increased markedly in
the three months to September, exceeding expectations. Profitability increased
at its fastest pace since March 2011. Insurance brokers expect robust growth in
volumes and profitability next quarter.

Jonathan Howe, PwC’s UK insurance leader said:

“The general insurance sector saw a modest improvement this quarter - profitability
rose at its fastest pace since March 2008 and business volumes showed a second
successive quarter of growth. The sector saw more positive results in the higher
fee and premium income, alongside a fall in costs.

"General insurers are faced with mixed outlook for next quarter - robust growth in
business volumes and an improvement in demand is expected, but there remains
caution over predictions of a future rise in compliance and claim costs. The
increasing requirements of the new regulator pushes the conduct agenda back to
the top of board's priority list. The sector should use this as a reminder of
the need to focus on changing customer needs and the opportunity that this
brings."

“Life insurers saw the strongest growth in optimism in three quarters, and the
industry is showing strong signs of recovery in contrast to the low
profitability concerns of previous quarters. A rapid increase in business
volumes is reflective of the increased confidence amongst life insurers,
bolstered by predictions of growing premium and investment income. Firm’s
historic concerns around skills shortages are being addressed, with increased
headcount which is expected to rise further. The search for growth opportunities
is still continuing, with investment in new technologies expected to increase".

Securities trading

Business volumes declined faster than expected, and, alongside a rise in costs, dented
profitability – which fell for the first time in three quarters. However,
profits are expected to grow in the next three months, and predictions for
business volume growth are the highest on record. Indeed, as a sign of
increasing confidence in the outlook, an expansion of capacity has become a key
driver of capital spending in the year ahead, and firms are showing a strong
appetite to develop new products and services to support growth.

Investment management

Business was slow over the summer, with volumes broadly flat – the first time that they
have not grown since June 2012. With pricing power squeezed, incomes stalled
and profits fell after strong growth in the previous quarter. Despite this,
investment managers remain optimistic about their outlook, with volumes,
incomes and profits are expected to recover in the quarter ahead. The sector’s
headcount continued to increase strongly in the three months to September.

Paula Smith, PwC’s UK asset management leader said:

“Buoyed by hopes in European equity markets and the positive tone of UK economic
recovery, investment managers remain optimistic about their outlook.  Headcount is climbing as firms gear up for renewed growth.  However, the costs of regulation and tougher competition are two clouds on the horizon.

“Over the next year, investment managers view levels of demand as a receding problem,
but competitive threats are an increasing challenge.  Investment managers see product development as an increasing priority, which reflects changes to regulation including the Retail
Distribution Review, the birth of the FCA and a variety of European initiatives.  However, it is also driven by the rapidly changing economic and investment outlook.”

Background

1. Full survey results can be obtained on subscription by contacting surveymanagementgroup@cbi.org.uk. Accredited journalists can obtain a full copy of the survey by contacting: press.office@cbi.org.uk.

2.The survey was conducted between 19th August and 5th September 2013.There
were 99 respondents. The survey began in December 1989.

3. A balance is the difference between the percentage of firms reporting an increase
and those reporting a decrease

4. The CBI is the UK's leading business organisation, speaking for some 240,000
businesses that together employ around a third of the private sector workforce.
With offices across the UK, as well as representation in Brussels, Washington,
Beijing and Delhi, the CBI communicates the British business voice around the
world.

5. PwC firms provide industry-focused assurance, tax and advisory services to
enhance value for their clients. More than 169,000 people in 158 countries in
firms across the PwC network share their thinking, experience and solutions to
develop fresh perspectives and practical advice. See pwc.com for more information.