Stronger than expected economic growth in 2017 bolstered profits, reduced unemployment, and helped slow gains by populist leaders. But financial institutions now face mounting risks from potential asset-price bubbles and a fast-approaching Brexit deadline. Most importantly, we see large financial firms focusing on scenario planning, as 2018 could be a volatile year. How can firms stay vigilant and nimble to seize opportunities and manage risks?
Upside surprise. Global economic growth beat many expectations in 2017. Global trade, investment, and industrial production rose, and growth hit an impressive 3.6%. The US economy strengthened too, expanding at a 2.2% pace. Meanwhile, investors seeking yield bid up prices across asset classes, raising the risk of market instability. Elsewhere, China’s GDP growth has flattened, and the foundation for its boom remains shaky. Beijing needs to rein in credit growth and curb rising property values. The world is watching, as China remains the biggest engine for global growth.
Crumbs from the Fed. The Fed raised rates in 2017 and signaled more rate hikes to come in 2018. It also began paring its US$4.2 trillion balance sheet, a main tool for stimulus. Albeit with slower timelines, there have been similar indications from both the Bank of England (BoE) and the European Central Bank (ECB). The unprecedented period of low interest rates seems to be at an end.
Populist movement gains momentum. The 2016 Brexit shock prompted concern that a new wave of populism would shake Europe. It didn’t happen, but nationalist politicians gained in Germany, Austria, and elsewhere. This has raised concerns for global financial institutions that rely on free trade.
Firing on most cylinders. The International Monetary Fund forecasts global growth of 3.7% in 2018. However, significant downside risks remain from potential oil price increases, monetary policy tightening by the Fed and BoE, withdrawal of stimulus by the ECB, the burst of an asset price bubble, and geopolitical risks such as North Korea.
Slow squeeze. The Fed will likely continue to slowly raise the benchmark interest rate over the next two years. This may depend on new central bank leadership as key positions turn over. We expect the BoE to incrementally raise its main rate, and the ECB has indicated it intends to halt its purchases of securities late in 2018.
Messy split and much yet to do. The UK is hurtling toward a March 2019 divorce from Europe, but UK leaders haven’t even agreed on goals for negotiating future trading arrangements and transitional arrangements. It looks like UK-based financial firms won’t gain “passporting rights” (the ability to operate in the EU with minimal additional authorization). Rather, UK-based institutions may function in the EU, after a transition period, under some less favorable form of “regulatory equivalence,” much as other non-EU firms do. Look for strong pressure from Europe for the lucrative euro clearing business to move from the UK to an EU jurisdiction.
You need a plan for everything. These days, we all have to monitor global events. If you operate in Europe, prepare for a “hard Brexit” and a lengthy disentanglement of the UK from the EU. In doing so, recognize that supervisors will focus more on firm governance and your ability to make timely, independent decisions in both the EU and UK. More broadly, it’s time to think about how you plan and how you demonstrate your capability to do so. This type of cross-border, multi-variable problem will likely strain the governance structures of many firms. Consider your readiness to handle whatever arises and how you’ll be ready to move quickly.
At home, prepare for the worst. With record asset valuations and soaring stock markets, pessimists are asking if this could be 2007 all over again. Institutions certainly learned a lot from the financial crisis, and balance sheets are the strongest they’ve been in a long time. But looming geopolitical risks and domestic political gridlock are big storm clouds on the horizon. Given the current tight labor market, some economists have predicted a 60% probability of a recession starting within the next two years. Take this time to reexamine your downside scenarios because you may need to bolster your contingency plans.
“The reality is that many of the uncertainties that existed around Brexit a year ago are still here. In fact, they're probably more abundant now.”
Financial services companies face an array of risks in the new year ranging from the impact of Brexit talks to the outlook for China's economy, the biggest driver for global growth. PwC's John Garvey and Neil Dhar describe how financial firms have shifted their list of priorities, moving concerns about regulation below their focus on the opportunities from artificial intelligence, robotics, and other digital technology.
Since the financial crisis, financial institutions have shifted from a global focus to a more regional or national approach. For investors, it's a different story. PwC's John Garvey and Neil Dhar say investors haven't wavered in their global orientation. Investors still move capital to wherever they can find the most promising opportunities based on their preferred balance of risk and return.
Our teams in asset and wealth management, banking and capital markets, and insurance are helping our clients tackle the biggest issues facing the financial services industry. With professionals across tax, assurance, and advisory practices, we can help you find ways to thrive even in a period of uncertainty. Whether you're preparing for regulatory changes, putting FinTech/InsurTech to work, or rethinking your human capital strategy, we work together with you to resolve complex issues, identify opportunities, and deliver value to your business.
Global Financial Services Leader, PwC US
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Global Financial Services Regulatory Practice Co-Leader, PwC US
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John W. Stadtler
US Financial Services Industry Partner, PwC US
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Global Growth Strategy, US Financial Services Practice, PwC US
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Leader, Financial Services Institute, PwC US
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