Figure 1: UK MFIs sterling deposits from UK resident businesses, 2013-15

(£ Billion outstanding of deposit liabilities, excluding under repo, not seasonally adjusted)

Source: Bank of England

Deposits from non-financial businesses have climbed in the past two years, supported by an improving macroeconomic environment. By contrast, deposits from financial businesses, particularly in the financial intermediation sector, have fallen as banks continue to scale back activity in certain financial sectors.

Deposits from non-financial businesses increased by 15% in the two years to March 2015. Despite indications of a slowdown in the first two months of 2015, March saw a recovery that took the total number of sterling deposits from non-financial businesses to almost £400 billion.

Figure 2: Forecast UK MFIs sterling deposits from UK resident non-financial businesses, 2015-19

(£ Billion at 2014 prices)

Source: MBD forecasts

The forecast for banks’ sterling deposits is positive, although the strength of growth will be heavily influenced by the performance of the economy. Deposits for non-financial businesses are expected to continue climbing incrementally over the forecast period, with cumulative real terms growth of 23% to 2019.

Figure 3: UK PNFCs net rate of return, 2010-14

(% return)

Source: ONS Profitability of UK Companies

The net rate of return for non-financial businesses averaged 11.9% across 2014. This was an increase from 11.2% in the previous year and represented the highest reported level since 1998.

While overall profitability is up, there is a significant difference in profit levels between the primary sectors of the economy. The net rate of return for manufacturing companies was 10.9% in 2014, compared with 16.7% for service companies. This latter figure is by far the highest seen in the service sector since the turn of the century and illustrates the comparative strength of its recovery since the downturn.

In March 2013, the Bank of England and the then regulatory body, the FSA, announced the results of a review into barriers to entry in the banking sector. The review announced a number of changes to relax rules for new entrants and make it easier for firms to become banks.

Measures included lowering the minimum capital requirement for new banks to 4.5% to stimulate start-ups, and offering an additional shortened, three-stage authorisation process focusing on essential elements. The changes came into effect at the start of April 2013.

Reports suggest that banking applications have increased substantially, with up to 30 processed by the PRA in late 2014. The applications have been encouraged by the new switching service, which has increased customer awareness of the ease of moving bank accounts. Most new banks aim to leverage technology in some way or market to segments of the society currently under-served by banks.

Aldermore has performed with increasing success in recent years, with customer deposits climbing by almost 100% in 2014 and loans to SMEs increasing to more than £2 billion. The bank reported a pre-tax profit of £51.8 million in 2014, more than 30% of its total operating income.

This performance has been matched by an accelerating share price since the bank’s initial public offering was completed in March, with shares trading at around 235p in early May, up from the 192p offer price.

It has been a tumultuous period for the Royal Bank of Scotland Group, as continued conduct and litigation costs have dogged the bank while it seeks to further rationalise its operations. After a turnaround in 2014 that saw a £2.6 billion pre-tax profit, the bank’s Q1 2015 results showed a fall in income of 14% and a negligible pre-tax profit.

Nonetheless, there was an improved picture for its commercial banking business in Q1 2015, when deposits climbed sharply by 14% compared with the previous quarter. The group will be braced for further conduct charges in 2015, while the sale of public sector shares is expected to be completed swiftly following the election of a Conservative government in May 2015.

There are obvious challenges facing the wider banking industry. The costs faced by the largest banks relating to conduct in consumer banking, and associated litigation, are estimated to require a further £19 billion by 2017. The last budget also ensured that they will face an increased bank levy, while challenger banks are presenting strong competition for SME business. Economic growth, meanwhile, appears to have slowed since the end of 2014 and most major banks are engaged in cost-reduction programmes.

That said, the underlying picture for commercial business is more positive. Income from commercial banking climbed year-on-year for Santander, Barclays and RBS Group in 2014 and net interest margins grew in many cases. The two key issues for major banks will be responding to the technology-led banking services provided by challengers and attracting profitable commercial business in an environment where costs will be rising due to ring-fencing regulations.