Optimism in the sector surged in the three months to September as firms reported being at their most positive for almost 17 years, according to the latest CBI/PwC Financial Services Survey.
Employment grew but business volumes fell unexpectedly, mainly in the banking sector.
Profitability rose for the fourth consecutive quarter, as companies managed to offset the fall in business volumes by widening spreads.
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.
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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.
Companies plan to spend less on land and buildings and vehicles, plant and machinery over the next twelve months but more on IT.
More than half of firms said that dealing with the new twin regulators (the Prudential Regulatory Authority and the Financial Conduct Authority) had contributed to an increase in costs.

Key sectors:
Life insurance
Sentiment rose for the first time in three quarters. Business volumes rose rapidly over the past three months, after declining for two quarters. Headcount increased and is expected to rise further. Recruitment is being driven by two key factors: regulation and strategic change.
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."
"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."
The survey was conducted between 19 August and 5 September.There were 99 respondents.