By Daniel Hunter

Bank lending to businesses in the UK will go up for the first time in four years, according to the Ernst & Young ITEM Club outlook for financial services.

Lending to corporates shrank by 5% last year, hitting the lowest level since 2006, but the outlook for lending this year is gradually improving, as corporate risk appetite starts to recover. Lending is expected to grow by 3% to £440b in 2013 and by 8.5% to £477b in 2014.

“In recent months much of the media and political attention has focused around banking competition on the high street and you might be forgiven for thinking we were still in the midst of the banking crisis but behind the scenes banking fundamentals have quietly been improving and banks are now in a better position to be able to provide funds to the wider economy," Andy Baldwin, head of Financial Services in Europe, Middle East, India and Africa, at Ernst & Young said.

“Our analysis suggests the main drivers of banks’ return to lending will be better access to wholesale funding and a decrease in non-performing loans, rather than the Funding for Lending Scheme making a material difference. That said the scheme is making a contribution in shifting emphasis and encouraging lending expansion across the sector while also helping to restore confidence and stimulate demand from consumers and SME's alike.”

As credit concerns ease and economic growth picks up, total loan write-offs are forecast to fall to 0.56% of total loans in 2013 (£9.3b), after peaking in 2012 at £11.6b. As a result, provisions against loan losses at UK banks are broadly expected to remain stable, and write-offs are expected to decline further by 2016 when they will make up just 0.34% of total loans.

However this forecast is dependent on the interest rate remaining at the current low level. There is an outside risk that non-performing loans (NPLs) have been understated and bank’s lending policies and NPL rates remain highly sensitive to even small interest rate changes.

“In some ways the current recession curve has not evolved as you might have expected. We have seen less insolvencies and less repossessions than in previous recessions, arguably because banks have continued with these weaker loans rather than foreclosed on them," Baldwin said.

"As a result NPLs are currently finely balanced and it wouldn’t take a significant shift in interest rates to increase the repayment burden of families and businesses across the UK, at great social cost and with a detrimental knock-on effect on lending.”

Carl Astorri, Senior Economic Adviser to Ernst & Young ITEM Club Financial Services Forecast says “Low interest rates are a mixed blessing. While NPLs appear not to have risen as much as in previous recessions, the companies being kept afloat are simply able to service their debts and are unable to invest or expand which continues to weigh on the economy, and presents a risk to banks if interest rates were to go up. The effect of low interest rates on margins, combined with weak demand is also curbing banks’ ability to lend to more profitable customers.”

The Help to Buy proposals put forward in the budget and increasing consumer confidence should boost the housing market. The number of property transactions is expected to rise by 7.4% in 2013 and 7.8% in 2014, with a million households predicted to move this year.

The sale of individual protection policies had fallen as housing market turnover dragged down traditional term insurance business but the uplift forecast in the housing market means that individual life insurance policy sales should begin to stabilise.

Between now and the end of 2016 10-year gilt yields will rise from 1.7% to 4.2%, which will make life insurer’s existing book of guaranteed business easier to serve as portfolio yields improve.

Carl says: “The slow economic recovery, uncertainty around Solvency II and the introduction of RDR, continue to make life difficult for Life Insurers but the predicted recovery in the housing markets will help to buoy the protection market. Increased yields from 10-year gilts will also make it easier for insurer’s to meet the demands of guaranteed business.”

Despite representing just 12% of Assets Under Management (AUM), multi-asset funds grew AUM by 22% last year. This was their fourth consecutive year of strong growth, and if the sector continues to grow at this pace it will manage a fifth of all UK-focussed assets by 2016 and be the second largest fund type after equities.

Figures for 2012 inflows show that 40% went into fixed incomes but figures from January and February 2013 show that fixed income funds saw their first outflows since October 2008 and that 88% of funds went into equities.

Carl says: “The global risk environment is normalising and so the market has turned. Investor behaviour will now be driven by valuation and fundamentals rather than a desire to preserve capital. The strongest growth in AUM will be in ‘risk assets’ like equities, high yield debt, multi asset funds and fund of funds.”

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