What is the outlook for financial services in 2023? Alex Ellerton explains the key challenges facing firms now and in the year ahead.

Economic uncertainty, geopolitical conflict, changing business models, new technologies and new regulations are just some of the issues you must navigate now as a provider of financial services. Here's an overview of the key trends in the sector, what you need to focus on and how to prepare ahead to improve customer outcomes and stay resilient in a challenging market.

Geopolitical tensions 

The geopolitical situation is having a significant impact on the UK and adding to the uncertainty. High energy prices, food supply chain shortages and broader supply chain issues are all key concerns for businesses. This has led to a changeable financial environment for firms, including high-interest rates, foreign exchange (forex) volatility and credit tightening.

So far, most financial services firms have generally fared well, demonstrating good operational resilience – though recent developments in the banking sector serve to re-enforce the need for a focus on resilience. The challenge does not only persist in the banking sector, however, and good scenario planning will help identify how these geopolitical factors can affect your business, helping you create effective contingency plans and mitigating controls. Well-governed use of multiple suppliers, outsourced service delivery via near-shore and off-shore models, and joint ventures may all contribute to an improved picture where firms are exposed to territories where there is a higher risk of unrest.

Economic outlook

As the country teeters on the verge of a recession, the UK faces inflation and a cost-of-living crisis. Higher interest rates are raising the cost of borrowing, and regulators will be keeping a close eye on the treatment of borrowers who are struggling. This is particularly pressing in the wake of government-backed lending during the pandemic, and the jury’s still out on the performance of those loans. With the implementation of the new Consumer Duty regulations now underway, it’s important to keep a close eye on conduct and make sure customers continue to experience good outcomes.

While high-interest rates are bad for borrowers, they're good news for savers and for banks, who are seeing material growth on their balance sheets as a result. Many economists believe interest rates may already have peaked, however. To stay robust in a volatile economy, it’s important to keep re-investing in key areas of growth, such as optimising in-house processes and embracing automation, to maintain good long-term profit margins and make the most of your human capital.

Reliance on buy now pay later and responsible lending

As UK households feel the financial pressure, business for buy-now-pay-later providers is booming. In the short term, these options can offer valuable support for consumers and help businesses weather periods of low demand. But consumers often focus on the purchase of the goods at the point of sale and not the long-term cost of borrowing (or even consider this type of arrangement with a ‘borrower mindset').

This is an increasing concern for regulators as higher-cost credit options can exacerbate cycles of persistent debt, which can be difficult to get out of. Affordable and responsible lending continues to need close consideration and remains a key concern this year.

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Embracing AI and tech

Since its November 2022 launch, ChatGPT has opened people’s eyes to a new world of possibilities for artificial intelligence (AI). This AI chatbot is particularly high profile – with an estimated 100 million monthly active users by January 2023 – which generally opens the door for new use cases and fuels innovation.

For financial services firms, AI use cases range from customer service desks, self-service portals, and risk or financial modelling, among others. The ability to automate simple, repetitive tasks can reduce pressure on resources, cutting costs and improving accuracy, giving more time for value-adding work. There’s also the ability to automate risk management controls, flagging exceptions in real-time for better monitoring and reporting.

But good oversight of AI is crucial, from assessing programmer bias to its application and ongoing supervision. As firms continue to embrace AI and tech changes, the financial sector needs to have broader conversations about the ethical use of AI, and how it can act to support good customer outcomes.

Changing business models

Digital transformation is burgeoning in financial services, with more firms adopting data-driven processes to inform decision-making and provide a greater range of digital journeys to customers. Regulatory sandboxes provide safe spaces to innovate and try new business models. However, it’s important not to leave any customers behind, especially with both government and regulators voicing concerns about financial inclusion. The result is further innovation in the form of banking hubs, pods and pop-up branches to help customers who prefer face-to-face interactions.

From a regulatory standpoint, this can be problematic, as regulation is being applied to business models it was never designed to fit. It'll be interesting to see how regulation responds to the changing needs of consumers – and the ensuing business models that are rising to meet them.

Regulating crypto

The Treasury recently announced a consultation on new regulations around cryptocurrency, mostly targeting consumer protection. This is particularly important as 5-10% of the population now hold some form of cryptoasset. Buyers tend to reflect a slightly younger audience, which may make them more vulnerable to risks of fraud or financial crime.

There’s also an emphasis in the consultation on seizing new opportunities, which will test the FCA’s new secondary objective to encourage the competitiveness of the UK’s financial markets. The Treasury recently told the Financial Times that it wants to be "more nimble and proportionate" in its approach than the equivalent EU crypto directive. The date of publication, ahead of the EU’s upcoming final vote on MICA (now due in April), is no coincidence and is organised to give the UK a competitive edge in this space.

The consultation feels optimistic in terms of time frames, however. Crypto is an inherently complex area and largely uncharted ground in terms of regulation. Implementation timelines are 2025 for the most high-risk assets but this may be optimistic in light of rapidly changing government priorities and a forthcoming general election.

Labour shortages

While labour shortages were an ongoing theme in 2022, London remains a top talent pool for financial services. A continued focus on agile working is helping firms attract talent from further afield, including from outside the UK, which is helping to bridge gaps. There’s also a focus on upskilling and retraining – increasingly important as automation is changing roles in many sectors.

Regulators are looking at the people agenda closely, with recent (and upcoming) consultations on diversity and inclusion (D&I). These themes have an important role in creating a competitive financial services environment in the UK, with a significant impact on performance. They also align closely with ongoing approaches to board effectiveness and governance that are trying to reduce 'group think' at a senior and board level and to improve accountability and decision-making. New D&I expectations will add a further element to existing governance and senior manager regime requirements, with clear movement expected in the people agenda overseen by boards.

Financial services outlook

The remainder of 2023 will be challenging for financial services firms. It is clear that a focus on the financial and operational resilience of all firms will be accompanied by real interest in the delivery of the Consumer Duty for retail financial services firms. Boards will need to carefully manage competing priorities, but putting customer needs at the centre of all business activity is essential, and it’s important to be able to demonstrate how you're acting to deliver good customer outcomes throughout. This needs to draw on all available quantitative and qualitative data to evidence how you bring real value to your clients throughout the life of a financial product. Outcomes must be tangible and extend beyond the point of sale. This approach to conduct will help you meet regulatory expectations while improving performance and accountability within your firm.

For more information and guidance, contact Alex Ellerton.

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