Total business volumes in the financial services sector fell slightly in the three months to December, marking the first contraction of demand since September 2013, according to the latest CBI/PwC Financial Services Survey.

Meanwhile, sentiment among financial services firms deteriorated further, rounding off three full years of flat or falling optimism.

The quarterly survey of 84 firms revealed a marked divergence in business conditions between sub-sectors, with sentiment holding up among insurers amid a continued expansion in their business volumes.

By contrast, volumes were flat or falling for banks, building societies and specialist lenders, while investment managers report the steepest fall in activity since the financial crisis.

Overall business volumes are expected to fall at a similar pace over the quarter to March, the first-time growth expectations have turned negative since December 2009.

Financial services firms - particularly banks, building societies and general insurers - see macroeconomic uncertainty as the most important challenge over the year ahead, ahead of regulatory compliance and preparing for the impact of Brexit.

Profits in the financial services sector as a whole remained flat for a third successive quarter, reflecting little change in business volumes and costs, the survey showed.

Investment managers and general insurers reported declining profitability.

In the three months to March, overall profitability is expected to fall for the first time in over three years, as a result of what the report’s author’s called “a more widespread deterioration in expectations across the industry.”

Key findings from the report were:

• 24% of firms said that business volumes were up, while 32% said they were down, giving a balance of -7% (down from +12% in the quarter to September)

• Looking ahead to the quarter to March, business volumes are expected to edge down further: 12% of firms expect volumes to rise next quarter, and 20% expect them to fall, giving a rounded balance of -9%, the weakest since December 2009 (-13%)

• Optimism in the financial services sector continued falling in the quarter to December (-24%, compared to -30% last quarter), having declined in all but one quarter since the start of 2016. 

Rain Newton-Smith, CBI chief economist, said: “A combination of macroeconomic and Brexit uncertainty, regulatory compliance and global market volatility are taking a toll on the UK’s financial services sector.

“Financial services are a bellwether for the wider economy.

“The persistent weakness in optimism and the deterioration in expectations sound a warning for the outlook.

“It’s clear the sector is grappling with a number of other challenges too, from using data to improve customer experiences, to new entrants to the sector.

“However, with new risks and demands come opportunities.

“Insurers in particular are pulling ahead, many of whom are moving into areas such as asset management outside of their traditional markets.”

Andrew Kail, head of financial services at PwC, said: “Continued economic and political uncertainty means last year ended on a more pessimistic note than previous quarters for many working in UK financial services.

“It's a broad industry, meaning optimism varies between sub-sectors and companies, but this survey shows that investment managers, who have been more immediately impacted by volatile stock markets, are gloomiest heading in to 2019.

“The underlying reasons for this dip in optimism have been around for some time – political and Brexit-related uncertainty, regulatory pressures and a sustained low interest rate environment impacting margins.

“Competition from established peers as well as new market entrants is also high on companies' radars.

“UK financial services firms looking to prosper in 2019 should concentrate on issues they can control.

“Most importantly, by focusing on clear strategies for delivering value through products and services which meet their customers' needs, maximising the efficiency of delivering these services - keeping operating costs under control - and using technology to augment the quality and efficiency of activities across their business.”  

Despite this outlook, firms expect to increase headcount in the quarter to March and investment intentions for the year ahead remain broadly stable.

Financial services firms plan to raise spending on marketing and IT at “robust rates”, and capital spending in other areas is expected to be unchanged.

Firms indicated that efficiency and replacement were the main drivers of investment, alongside statutory legislation and regulation.

The more pessimistic outlook for the financial services sector in the short-term was in keeping with the subdued prospects for the wider UK economy, with GDP growth expected to be held back by weak household income growth and the impact of Brexit uncertainty on investment.