Future Is Bright for Financial Services in 2018: The Economist

The EIU sees an upbeat year, despite lurking risks in China and other markets

The year ahead for financial services looks upbeat, and financial firms will start to settle into a steady state, the Economist Intelligence Unit predicts in a new report.

The EIU says steady economic growth, higher interest rates and a leveling off of re-regulation will renew financial firms’ confidence.

It says financial firms that thrive in this environment should have a leg up to face the future, but those that falter will have to rethink their business models rather than wait for better economic and operating conditions.

According to the report, moderate hikes in base interest rates in North America and the tapering of asset purchases in the eurozone should lead to somewhat higher bond yields, attracting investors back into fixed income instruments and taking some of the shine off stocks. However, central banks will proceed gradually, limiting the effects.

Whatever happens in the back and forth between stocks and bonds, investors will continue to seek out low-cost investment vehicles such as exchange-traded funds. The EIU predicts that the shift to such funds will run strong in 2018 as investors focus on reducing the fees they pay.

It also expects further consolidation among the providers of these funds.

A growing number of financial firms will return to levels of profitability that exceed their cost of capital in 2018, bolstered by stronger business volumes, improved operating margins, better returns on investments and the results of cost cutting.

The EIU finds, however, that many firms are poorly situated geographically to take advantage of the strongest areas of growth. They are overweight mature and developed markets and underweight faster growing emerging ones.

Then there is high-growth China, where insurance volumes are booming but few non-Chinese firms are in a position to benefit.

A large number of firms are still engaged in basic restructuring, and others that had to be rescued during the financial crisis are only now pulling themselves together as governments sell stakes and refloat them on stock markets.

Banks in Asia’s big economies are out front in exploring new territories, gaining licenses in many markets around the globe, usually for simple branch operations, according to the report. They are avoiding complicated acquisitions and involvement with retail operations, and looking for corporate and investment business as companies from their home markets expand globally.

Regulatory Plateau

The EIU predicts that financial regulation will plateau in 2018. Firms still have this year to comply with core Basel III rules, which will go into full force in January 2019.

As well next year, the consequences of new automatic tax information sharing between countries should become evident. The report says authorities will likely crack down on individuals and companies that hide undeclared, untaxed assets in foreign markets. This will take the shine off jurisdictions such as Singapore and Switzerland, which are known for keeping their clients’ secrets, but the EIU expects these financial hubs to retain their overall appeal.

Don’t expect a major rollback of regulatory tightening that seemed to be afoot following the Brexit vote and Donald Trump’s election. The report says any shift in the U.K. will have to wait for the country’s exit from the EU in 2019, and in the U.S., the administration has been less than adept in assembling a legislative majority around its key proposals.

The report says regulators will step up supervision, as well as facilitation, of innovations in finance, such as mobile banking, robo-advisors and on-demand insurance. This could get heavy-handed. Witness China’s recent crackdown on cryptocurrencies.

The report highlights some major risks in hard-to-measure places. The run-up of Chinese debt is the prime example, a peril China’s leader, Xi Jinping, has promised to tackle next year.

India’s state banks are awash with bad loans. In 2018, the government plans to recapitalize its lenders as a first step in addressing the problem.

The EIU predicts that troubled banks in Russia and southern Europe will continue to fail, but in most cases, local taxpayers will shoulder the costs.

Three U.S. Firms

The report lays out predictions for several global institutions, including three U.S. firms.

Goldman Sachs finds its fixed in­come desk (specifically its commodities unit) in need of a revamp. The firm is going to restructure the unit, much as its smaller rival Morgan Stanley did in 2016. This will probably involve job cuts, less focus on hedge funds and automation of some trading operations, the EIU says.

Anticipating a “hard” Brexit, Citigroup will move its private banking headquarters in Europe from London to Luxembourg. It will also base its trading and capital-markets operations in Frankfurt. The EIU said that after details of the Brexit negotiations become clearer next year, many more banks will scale back operations in London.

Additional issues relating to Wells Fargo’s fake-accounts scandal could come to light next year. The institution’s chief executive, Tim Sloan, says that the bank has hired external consultants to dig into and assess its practices and that this could lead to “additional headlines” in the near term. Meanwhile, Wells Fargo’s cost-cutting program will forge ahead with the aim of closing 400 branches by the end of 2018.

--- Check out Neil Hennessy: ‘Get in Front of a Correction’ on ThinkAdvisor.

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