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Summer is still a long way off for the financial services sector

Ian Ingram
Jun 3, 2013 3:56:00 AM

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The weather is pretty filthy, given it’'s almost summer. And summer looks like it might be a while coming in the financial services sector, too.

You know banking is still in a bit of bother when a really quite positive Ernst & Young (EY) report on its outlook begins: “"Although the banking sector is not yet in a position to contribute to economic growth, we expect it to act as much less of a brake on the UK economy in 2013 than in the past five years."” Talk about damning with faint praise.

The pain seems pretty evenly spread. You'’ve got the Co-op'’s woes (caused in part by a problematic IT procurement issue); ongoing disposals by banking groups like Lloyds (St James's’ Place, international private banking) and RBS (which is coming to the end of a long sell-off programme); and fresh rounds of redundancies, at Lloyds, HSBC and, well, lots of places.

The good news is that in banking, insurance and asset management, things are at least relatively fluid. Management teams seem to have grasped the nettle (or been removed in favour of executives with more of a grasp) of what needs to be done and are attacking on several fronts.

Those headcount cuts grab the headlines, of course. But two other stories are important for this sector. First is deleveraging, driven by capital adequacy rules in banking and Solvency II in insurance. In both cases, there’'s some uncertainty about how market players will settle into the new regimes. But according to EY, for banks at least “the "deleveraging process seems to be coming to an end."”

Operationally, however, things remain tight. Insurance companies are seeing falling business thanks to new regulations designed to reduce churn. And at the banks, wafer-thin margins on a range of activities remain a concern as low interest rates suppress their room for manoeuvre. Bottom-line? When rates and spreads are low, every penny spent running the business has to work harder.

Crucially, there'’s nothing financial services companies can do about the regulatory shifts. They just have to eat it. So it'’s not surprising that EY highlights cost control and efficiency as two critical factors for the sector.

Life insurance, for example, which took a body-blow during the recession as policyholders made do without cover, has to change. “"As challenging market conditions persist, life insurers have been forced to improve investment and asset/liability management, as well as reducing operational costs, improving underwriting, and adjusting policyholder bonuses and crediting rates,”" explains the EY report.

And the banks? Well, there’'s evidence that the smarter approach to costs is working. HSBC, which acted early on costs, reported a doubling of pre-tax profits to $8.4bn earlier this month. And look: a massive 85% of that increase came from exceeding its annual cost savings target of $3.5bn.

Of course, the key is making the right cuts. Barclays, for example, laid out a new strategy when announcing its results in February and promised a leaner approach. It’'s not about arbitrary budget or headcount cuts -– it’'s looking at the business and deciding what parts work, what don'’t and how you want to operate. At that point, deciding how to deliver operationally -– how to procure smartly and who to employ -– is driven by the strategy, not the budget.

Not only does that approach promise more sustainable savings. It also makes the business leaner and more likely to fully exploit improving conditions. (The markets agreed in the case of Barclays: after its results and strategy call, its shares hit a two-year high.) EY'’s report says that summer is coming -– things are looking up for both banking and insurance. It’'s the tightly managed, agile financial services players that will prosper when the sun comes out.
Ian Ingram

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