UK financial institutions: strong and stable

While the macroeconomic environment may have shown some initial signs of settling in recent months – with inflation in some regions being reined in and interest rates predicted by many to eventually move south – the overall macroeconomic and political backdrop remains challenging for lenders.

Ben Locke, Head of Speciality Finance at HSBC UK Financial Institutions and, with nearly 15 years’ experience developing existing and facilitating new relationships across the Financial Institutions sector in London and beyond – as well as a background in Global Cash Management and Corporate Business Development – is well-placed to assess the current market outlook.

“In terms of the outlook for 2024, I don’t think much has changed a great deal compared with last year,” Ben explains. “There is still a great degree of uncertainty across the market rate environment, with the outlook changing frequently – in fact more recent inflationary data suggests that, perhaps we won’t see interest rates falling quite as quickly as people were forecasting even just a few months ago.”

That uncertain outlook is also paired with increased political uncertainty this year, with more people going to the polls around the globe in 2024 than in the entire history of democracy – which is likely to result in substantial political changes across a number of key economies.

Add to those elements the fact that the UK “continues to fly very close to the sun in terms of economic performance”, according to Ben – with many sectors, such as construction, demonstrating ‘recessionary traits’ – and it’s evident the world has entered a ‘new normal’ era of greater volatility when it comes to how markets might perform year to year, and even month to month.

In such an environment, financial institutions, with their scale and stability, are ideally placed to help navigate this complex market backdrop.

For Specialty Finance businesses, particularly those facing consumers or funding clients that face consumers, underwriting in a more volatile market can be far more difficult.

For example, in a normalised interest rate environment, the dynamics of a good credit looks very different to what it did in a zero-rate environment or the unique environment we witnessed through Covid-19 – where forbearance was demonstrated in a unique, un-normalised way.

“As a result of that, teams that have a deep experience operating through more conventional economic cycles will likely be best placed,” explains Ben, who also expects Speciality Finance firms to face challenges to their levels of profitability in the current environment.

“We’ve seen a general contraction in profitability, the cost of financing has gone up exponentially, and passing on those costs has been quite difficult – and that’s besides all the other inflationary pressures these businesses have faced,” he says. “Therefore, those businesses that have strong equity partners that can provide them with access to different pools of liquidity to help finance them are likely to be more strongly placed to perform through this next phase of the cycle.”

For Speciality Finance businesses, this landscape lends itself to partnering with strong institutions to support their business in multiple ways.

“At HSBC, we build multidimensional relationships across the full breadth of the speciality finance sector,” Ben adds. “We cover Consumer, Mortgage, SME, and NPL finance companies across a range of bespoke sub asset classes and our capabilities in the sector include asset financing, corporate finance, all transactional banking requirements, FX and rate management, issuer services, trade solutions and access to a range of deposit solutions. We can support a business in anyway it might possibly need in the UK and beyond.”

With many tech-based platforms in particular having never previously experienced the current set of macro conditions; those platforms’ underwriting models are set to be tested for the first time.

“We will start to find out how these perform in a more normalised environment that is perhaps not quite as benign as the prior cycle,” Ben explains. “We will find out, for example, how AI underwriting is going to stand up to a far more unique test while it’s still ‘learning’ itself.

“I think there are unique challenges to the more tech-enabled platforms and that comes back again to that point around equity and having strong partners behind the business to support them – as those types of businesses undoubtedly have to navigate some bumps in the road as they evolve through the next stage of their lifecycle.”

We will also likely see the emergence of new asset classes, powered mainly by the ongoing attention being focused on sustainability.

This is already an emerging trend, with the first EV securitisations already being conducted, and funding of other green assets, such as home improvements, solar panels, and air source heat pumps also evident in the market.

“That is likely to be a theme that continues, particularly as economies such as the UK strive to achieve their broader transition goals,” Ben explains. “In fact, there is a growing cultural and political shift to finance the transition. Many banks and institutions have their own plans and are embracing the desire to be part of financing the transition. And I guess the next step in that is originators themselves, non bank originators, coming on that journey as well.

“We are starting to see a greater divergence between those that have more mature attitudes and approaches to how they think about sustainability for their businesses, and those that are just at the start of their journey. Linked to that, some businesses are working with us to try and build in very clear sustainability-linked objectives to their financing.”

In the pre-Covid environment and, to a degree, part-way through the pandemic, very little attention was given to interest rates due to their prolonged low period.

However, with rates now a much bigger issue – and with so many consumers having never experienced rate volatility – more attention is now being given to how some products are structured.

“We are seeing some businesses think far more carefully about how they structure their products and what that really means to a consumer – how does it align to the consumer’s desire and what they want from their products?,” Ben says. “That’s also creating a need for businesses themselves to consider how they manage that risk – which they haven't had to think about for a huge period of time.”

While it’s challenging to predict the future at any time – and even more so at times of economic volatility – a number of factors look set to test policymakers and the sector beyond this year.

“The current volatility around the macroeconomy and the uncertainty that is delivering around performance continues to challenge policymakers on how to manage emerging risk in that regard,” he says.

“We also have a political environment that is uncertain,” he adds. “That in turn impacts the regulatory environment - and we already see that some actors in particular are already facing extreme scrutiny from the regulator in a way that hasn't been seen for some time.

“With this being played out against re-militarisation in certain parts of the world, which may further challenge supply chains – coupled with the demographic change we are seeing – this whole environment is testing policymakers in a way they haven’t been tested before.

“So going beyond 2024, I think this environment will test businesses in a way that’s far more dynamic, that has far more pace to it, and in which they need to be able to evolve and adapt very quickly.”

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