While deposits from non-financial corporations have climbed in the past two years, those from financial businesses have fallen, particularly in the financial intermediation sector, as financial institutions scale back activity in some sectors. Deposits from all financial businesses fell by a cumulative £92.8 billion, close to a 10% fall, to a two-year low of £860.5 billion by December 2015.

Figure 1: UK MFIs Sterling Deposits from UK Resident Businesses, by Quarter End, 2014-15, (£ Million Outstanding of Deposit Liabilities, Excluding Under Repo, Not Seasonally Adjusted)

Source: MBD analysis of Bank of England data

The largest industry block by deposit value in the UK is professional, scientific and technical activities, which includes companies in the legal, advertising, scientific research and engineering sectors. These account for just over 17% of total non-financial businesses (NFB) deposits combined. In the past two years, deposits are understood to have increased notably in the retail sector, where sales have grown amid climbing disposable incomes. Deposits from the real estate sector have also increased on the back of a strong property market where transactions are climbing. This sector accounted for just over 10% of total NFB deposits in December 2015.

Figure 2: MFI Sterling Deposits of UK Resident Non-Financial Businesses, by Industry Type, Top Eight, December 2015, (Share of Total)

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Source: MBD analysis of Bank of England Bankstats

From Q4 2013 to Q4 2015, gross loans to all businesses totalled £442.8 billion, peaking at £52.5 billion in Q4 2015. Over the review period, large businesses accounted for 72% of gross loans obtained. Loan repayments made by SMEs remained at a fairly consistent rate over the review period - ranging between £12.6 billion and £15.4 billion per quarter. Meanwhile, loan repayments made by large businesses varied between £33.1 billion and £43.4 billion over the same period. In total, businesses repaid £459.5 billion of loans over the last nine quarters.

Average interest rates for UK MFI new advances to PNFCs declined by 0.6 percentage points between December 2011 and 2013 to a review low of 2.38%. However, over the next two years to December 2015, average interest rates increased by 0.38 percentage points to 2.76% - albeit still below the review peak rate seen in December 2011 of 2.98%.

Figure 4: Average Interest Rate for UK MFI New Advances to PNFCs, at December 2011-15, (% Not Seasonally Adjusted)

Source: MBD analysis of Bank of England data

The Bank of England’s Credit Conditions Survey suggests the overall availability of credit to the corporate sector increased appreciably for large businesses from Q4 2012 (defined as those with turnover in excess of £25 million). However, Q2 2015 recorded the first quarterly decline in corporate credit availability since Q2 2012, with corporate credit availability for large businesses declining again in the most recent data for Q4 2015.

Figure 5: Availability of Corporate Credit to PNFCs in the Last Three Months, Q1 2010 - Q4 2015, by Business Size, (Net Percentage Balance)

Source: MBD analysis of Bank of England data

According to the ICAEW/Grant Thornton Business Confidence Monitor, business confidence fell to a low of -36.3 at the onset of the global financial crisis in Q4 2008, before recovering to a high of 37.3 in Q2 2014. However, confidence has fallen in each subsequent quarter to 15.6 in Q4 2015 - a two-year low. In the latest quarterly figures for Q1 2016, the confidence index has remained in positive territory, but now stands at a three-year low of +11.4, compared to +15.6 in Q4 2015 and the high of +37.3 in Q2 2014.

Figure 6: Business Confidence Index, per Half-Year, 2005-2015, (Index Figure)

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Source: MBD analysis of ICAEW/Grant Thornton data

Across the industry, ad spending rose between 2012 and 2014 as banks sought to capitalise on new regulation facilitating the quicker switching of accounts. Spending on advertising also climbed across the board as banks engaged in significant brand-building promotions to repair the industry’s damaged reputation. This was caused by banks’ role in the lead up to the recession, plus high-profile redresses being paid for conduct issues such as mis-selling.

There was a significant drop in spending on business banking advertising in 2015, with expenditure declining by close to 36% as Lloyds, HSBC and Santander all significantly cut spending compared to both 2013 and 2014.

Lloyds still spent £3.3 million on its business banking advertising expenditure in 2015, accounting for 29% of total spend in the categories covered. The bank’s advertising spend covers additional brands in the group, including Bank of Scotland. However, its advertising expenditure fell for the first time since 2012.

Figure 7: Advertising Expenditure on Business Banking Services, by Advertiser, 2011-15, (% of Total Ad Spend)

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Source: MBD analysis of NMR data

As a barometer for business performance, movements in GDP are a significant indicator for the commercial banking industry. Given that medium and large-sized businesses make up more than 65% of total private sector turnover in the UK, economic output strongly determines the level of transactions and services private companies require from banks. Preliminary estimates for Q4 2015 put economic growth at 0.5% - resulting in annual growth of 2.2%. In Q4, output increased in three of the economy’s main industrial groupings - services increased by 0.7% and agriculture increased by 0.6%. In contrast, production decreased by 0.2% and construction contracted by 0.1%.

The turnover generated by the largest companies in the UK demonstrates their importance to the commercial banking sector. Businesses employing more than 250 people are a significant presence in the economy, contributing to 53% of private sector business turnover. They also account for 40% of people employed by privatesector businesses in the UK. Opportunities to expand commercial banking business increase as the turnover of medium and large-sized firms grows. With business confidence dependent on whether the slowdown at the end of 2015 persists into 2016, the UK’s ongoing macroeconomic performance will determine if the banking sector can capitalise on this growth.

Higher profitability in the economy boosts the commercial banking sector, with increased deposits facilitating greater lending and a more positive environment for business investment. The net rate of return for non-financial businesses was just over 12% in 2014, up from 11.2% in the previous year and the highest reported figure since 1998. Data for Q1-Q3 2015 suggests that the net rate of return for 2015 will be similar to 2014. Investment increased alongside profitability in 2014 and is expected to continue to grow in 2015. Data covering the first three quarters of 2015 suggests that levels will be higher than in the previous year, implying that business confidence is still growing. The average annual expansion in business investment between 2010 and 2014 was 4.6%, and is estimated to increase by 5.4% in 2015.

The Bank of England reported that net lending under the Funding for Lending scheme fell by £810 million in the final quarter of 2014. This provided a further reminder of the importance of small businesses having different types of finance available to them. The scheme has been deemed somewhat of a failure, as the total decline in lending over 2014 reached £2 billion. On the other hand, data published in May and September 2015, and January 2016 representing Q1, Q2 and Q3 2015, showed an increase in net lending by FLS Extension participants to SMEs of a respective £610 million, £448 million, and £675 million per quarter.

In May 2015, the FCA formally launched its investment and corporate banking market study following the evidence it discovered in July 2014 and published in February 2015. The FCA found evidence of investment and corporate banking sectors not working well for users, and possible competition issues and conflicts of interest in relation to the transparency of information and the bundling of cross-selling of services. The FCA planned to publish an interim report by the end of 2015, but this has now been delayed to spring 2016.

Most commercial and business finance is still conducted by the ‘big four’ banks - Barclays, HSBC, Lloyds Banking Group and RBS Group. This is largely because many commercial operations already have an account and therefore an existing relationship with one of these banks. Companies assume that the process of gaining finance will be quicker and less complicated as the bank knows their business, which is not always the case.

Over the past few years, increased regulation of the finance industry has placed mounting pressure on lenders to retain market share and improve their balance sheet totals. When the 2008 financial crisis and resulting political scrutiny forced high street banks to withdraw from the large loan market, it was left largely to private banks and specialised alternative finance firms to supplement the financing gap.

Underpinned by the regulatory crackdown on banks, a growing presence of asset managers, insurers, private equity groups, hedge funds, peertopeer groups and other pooled structures are lending to companies.

The population of banks and building societies operating in the UK has remained stable since 2013, following a period of consolidation after the 2008 financial crisis. Historical data from the Bank of England is available as far back as March 2013.

Figure 8: Number of Banks and Building Societies Operating in the UK, 2013-15, (Number)

Source: MBD analysis of Bank of England data

The combined income of the companies profiled in this report fell by 21% between 2010 and 2012 following the onset of the recession. Income rebounded in 2013 to £104.5 billion, before then falling to a five-year low of £90.7 billion in 2014 as misconduct charges and banking operations became more heavily regulated.

The UK’s economic recovery looks less stable approaching the first quarter of 2016. Concerns remain over the strength of the Eurozone recovery, growth is declining in China, and the slowdown in construction growth seen over the second half of 2015 has increased the burden on the service sector to drive UK GDP growth. Preliminary figures for Q4 2015 estimate that growth slowed to 2.2% in the year, compared to the 2.9% recorded in 2014. Banks’ interest incomes are therefore likely to lower this year with higher impairment losses. Despite the downgraded forecasts, the outlook for banks’ sterling deposits remains positive - although the strength of growth will be heavily influenced by whether the UK remains part of the EU following the referendum in June 2016. Deposits for non-financial corporates are expected to continue climbing by between 6% and 7% over the next five years, with cumulative growth of 29% to 2020.

Figure 10: Forecast UK MFIs Sterling Deposits from UK Resident Non-Financial Corporations, 2016-2020, (£ Billion at 2015 prices)

Source: MBD forecasts

There remain threats to the UK’s position as a leading international banking centre. Unilateral UK regulation, such as ring-fencing, entails significant costs to some UK-based banks, while extraterritorial regulation, such as the European Market Infrastructure Regulation, makes it harder for UK-headquartered banks to compete abroad. This has implications for commercial banking customers, with fees for commercial banking services likely to rise and credit availability somewhat restricted. Costs will not fall evenly across the banks, with some likely to face greater disruption than others.

The growing shift to low-cost business models across industries needs to be addressed by the major banks, with the chairman of Lloyds, Lord Blackwell, stating that “there will more change in the next decade in banking than there has been in the last 200 years”. Banks are under pressure from new entrants to the market, which have lower operating costs and cost/income ratios than incumbent banks, meaning that they can remain profitable while still offering a good service to customers.

For banks to remain competitive in an increasingly ‘customer-centric’ environment, they need to match the challenger banks’ approach in accelerating the digitisation process across their business operations. Customers want accounts opened in minutes and expect banks to have access to all their data. ‘Around-the-clock’ availability, intuitive interfaces, real-time fulfilment and personalised treatment with across-the-board consistency and zero errors are becoming differentiating factors, while underlying products and services become commoditised.