The return to growth in the eurozone economy is fuelling a recovery in key drivers of profitability for financial services, with companies looking to borrow again and cash flow for households and businesses has improving.
But the road ahead is not without obstacles according to The EY Eurozone Financial Services Forecast (EEFSF), a quarterly publication produced in cooperation with Oxford Economics, a leading independent forecasting and research institute.
The upcoming Asset Quality Review (AQR) and the insurance industry’s vulnerability to changes in interest rates present challenges.
Marie Diron, senior economic adviser to the EEFSF, says: “The eurozone has emerged from its longest recession in at least three decades and, although GDP is expected to fall by 0.5 per cent this year, activity will gradually pick up. As a result the growth in supply and demand for financial services is starting to return.”
Andy Baldwin, global head of financial services at EY, adds: “Over the summer we saw signs that a sustainable economic recovery in the eurozone may finally be under way. But a number of challenges remain before we will see a return to profitability and, more importantly, stability in financial services. Not least the unintended consequences and legacy of well-intentioned regulation.”
AQR process coincides with renewed demand for capital from the real economy.
After contracting for seven consecutive quarters, business investment is expected to pick up again this year. Improving GDP growth and credit conditions are gradually feeding an increased willingness to borrow. After a contraction of two per cent in 2013, eurozone banks are forecast to lend €4.6 trillion to business in 2014 – 3.8 per cent more than in 2012. Growth in business lending is forecast across all the major Eurozone economies in 2014.
In Italy it is forecast to grow 3.8 per cent, in Spain it will grow 3.2 per cent and in France and the Netherlands it is predicted to grow 2.7 per cent. Signs that exports are at last beginning to revive will drive particularly strong growth in lending in Germany – five per cent in 2014.
Consumer credit conditions eased in Q2 2013 for the first time since 2007. Consumer lending is predicted to grow by 1.7 per cent overall in 2013, but this growth will be centered in Germany and France, where lending will increase by three per cent and 2.6 per cent respectively. In Italy, Spain and the Netherlands lending to consumers will not start to grow until 2015. Residential mortgage lending is already expanding again this year in Germany, France and the Netherlands but not until 2014 in Italy and 2015 in Spain.
Baldwin says: “The forecasts show that cash flow is improving and companies are ready to borrow. But, somewhat ironically, just as credit demand starts to recover, the banks are preparing for the AQR and the further balance sheet pressures this may cause. Whether the AQR will allow banks to begin the transition to growth agenda or will trigger a further round of restructuring and capital raising is hard to say, but it has the potential to push recovery out to beyond 2014 and potentially even further in some markets.”
Bank deposits are growing rapidly at a forecast rate of 3.2 per cent in 2013 and 3.6 per cent in 2014, considerably higher than the 0.9 per cent growth seen in 2012.
Deposits are growing across all the major markets. Non-performing loans will peak at 7.8 per cent of total loans in 2013, falling to 4.6 per cent in 2017. And, while total bank operating income (profit realised after taking out operating expenses) will improve by just one per cent this year, it is set to rise by 7.1 per cent in 2014, as banks put the worst of the provisioning behind them.
Interest rates are forecast to remain low until H2 2017, when the ECB is expected to start raising the rate slowly from the current 50bp to 100bp by the end of 2017.
Andreas Freiling, EMEIA Insurance Leader, says: “European insurers remain very vulnerable to interest rate changes. While rapid interest rate rises could hit profits, growing longevity risks mean that low interest rates are putting balance sheets under ever-greater pressure.
If the ECB keeps rates at their current levels until 2017, this will create a serious challenge to the life industry. Another two years of very low rates will pose an existential threat to some European insurers.”
Although Assets Under Management (AUM) grew just two per cent in H1 2013, assets in pan-eurozone funds are still forecast to grow by 6.1 per cent this year to €4,817 billion.
However, this is just half the 12 per cent rate of net expansion in 2012, and average AUM growth is expected to reduce further to 3.9 per cent between 2014 and 2017, well below the historic average of 6.7 per cent.
The forecast for AUM growth across the eurozone varies considerably, reflecting investors’ exit from safe haven bonds in France and Germany as they search for value in peripheral European markets.