Is it all bad news for the financial services industry?

1st October 2012

Should this come as any great surprise given the ongoing backdrop of deleveraging in all areas of society and the commonly accepted need to rebalance the country's economy away from finance?

The headline figures of the quarterly CBI/PwC Financial Services Survey reveal that the sector suffered an expected drop in business volumes over the three months to September – its first drop since June 2009. Profitability also dropped for the first time in over three years, with financial companies reporting increased costs and a fall in employment.

But can any positives be gleaned from this downbeat survey? Looking past the headlines, the results show evidence that the sector is acting pretty much as it should be given the wider picture.

To be clear, a fall in financial services output is never going to be good news. The sector's role in supporting activity in every other part of the economy makes it critical to any kind of recovery.

Focusing on where business fell in the third quarter offers a more sobering view, however. Lending to other financial institutions and private individuals dropped over the quarter – not surprising when banks and households are being told to slash their debt by almost every commentator.

In its annual health check on the UK economy, the International Monetary Fund said the country's banks need to strengthen their balance sheets "by building capital rather reducing assets". It's not a groundbreaking point to note that this can only occur if they scale back lending to some customers and avoid leveraging themselves further.

And as the UK household gross debt to GDP is the highest of any G7 nation and the IMF warned that household debt remains high despite efforts to deleverage there, a convincing case can be made that private individuals shouldn't necessarily be the ones to receive any available bank funding.

Better news can be found when looking at where financial services' business volumes rose over the most recent three-month period.

Kevin Burrowes, UK banking leader at PwC, said: "Growth in retail banking has come to a halt as the banks focus more on commercial than consumer lending.

"It is promising that commercial business is growing again, which reflects the banks' increasing efforts to meet social and economic expectations by increasing their lending to businesses."

As the survey shows, there was a net 25% increase in lending to industrial and commercial companies – the part of the economy we are pinning our recovery hopes on.

Compare this with the CBI/PwC survey for the three months to June, which showed the industry was benefitting from "strong growth" overall. Here, business with private individuals rose at a solid pace but that with industrial and commercial enterprises was essentially flat.

Admittedly, the recent rise in lending to businesses comes from a low baseline. But as the Government has made clear that it wants a private sector-led recovery, it is only positive that lending is heading back in this direction.

In his 2012 Budget statement, chancellor George Osborne presented "a deliberate strategy to create a more balanced national economy, where financial services are strong, but they are not the only string to our bow".

The Government has highlighted industries such as manufacturing, aerospace, energy, pharmaceuticals, creative media and science as the ones to back for future prosperity, not financial services.

A healthy financial sector would of course benefit all these other industries. But as financial institutions face deleveraging and reform on an unprecedented scale, we would be unwise to expect financial institutions to ride to the rescue of all segments of society in the near future.

We want banks to bolster their balance sheets. We want them to lend to the areas of the economy that will stimulate sustainable growth. And we don't want households to take on more debt. The CBI/PwC survey might suggest this is happening.

So best to take the good news where it can be found. By no means should a fall in financial services' activity should be welcomed – but any indication that the banks are finally prioritising channelling money into the right places should be given some applause.


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The Financialist

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