New research published by the City of London shows that tighter EU regulation could significantly reduce growth in the financial services industry. This is the third edition of the annual report on “The Importance of EU Wholesale Financial Services to the EU Economy,” prepared by London Economics for the City of London Corporation.
The study – commissioned as part of the City Corporation’s ongoing research programme – predicts that the credit crunch will cause 75,000 job losses across Europe, mostly in major investment banks. Other financial services sectors – such as insurance and commodities – should be more resilient.
The report identifies five key factors which will determine the performance of the financial services industry over the next five years: the regulatory environment; the state of the world economy; the evolution of domestic savings; competitive pressures from outside the EU; and changing business models. Four scenarios for the evolution of the financial services industry to 2012 are presented below. Each scenario assumes a different combination of positive and negative influences from the key factors.
In the most likely scenario, financial services gross value added (GVA) falls by 8.3% over 2007-2009. The industry is expected to recover in the medium-term, though, with GVA in 2012 reaching 0.7% above 2007 levels.
The Benign scenario (1)
Probability it happens: 20%World growth: As predicted by IMFRegulation: Minor changes, such as remuneration guidelines and tighter supervision.
Competitiveness: No loss of competitiveness, exports continue to grow% change GVA* 2007 – 2009: – 4.8%% change GVA* 2009 – 2012: + 13.7%
The Challenging scenario (2)
Probability it happens: 40%World growth: as predicted by IMFRegulation: Tightening: Increase in capital holding requirement; limited scope of activityCompetitiveness: Falling competitiveness and exports% change GVA* 2007 – 2009: – 8.3%% change GVA* 2009 – 2012: + 8.4%
The Stressful scenario (3)
Probability it happens: 25%World growth: % lower than IMF predictionsRegulation: Tightening: Increase in capital holding requirement; limited scope of activityCompetitiveness: Falling competitiveness and exports% change GVA* 2007 – 2009: – 11.2%% change GVA* 2009 – 2012: – 2.9%
The Positive Surprises scenario (4)
Probability it happens: 15%World growth: % higher than IMF predictionsRegulation: Limited changes with no impact on the sectorCompetitiveness: No loss of competitiveness, exports continue to grow% change GVA* 2007 – 2009: – 2.6%% change GVA* 2009 – 2012: + 15.9%
“This report makes clear that the financial services industry faces difficult times ahead,” says Stuart Fraser, chairman of policy and resources, City of London. “Some of the challenges, like the health of the world economy, are outside the control of EU governments. But Europe can act now to make sure that financial regulation is part of the solution, not part of the problem.
“We are particularly concerned about the proposed amendment to the EU Capital Requirements Directive. This change would greatly increase the cost of capital across Europe, with detrimental effects far beyond the financial services industry. Any new legislation should be developed according to the EU’s own principles of Better Regulation, including a reasonable consultation period and a full impact assessment – so far, we have seen neither.”
“Sensible, principles-based regulation will help the EU to maintain its competitive edge as the world’s largest exporter of wholesale financial services. There is a lot at stake here. Not only do 1.4 million people work in the sector across the EU, but financial services are a driving economic force, accounting for two-thirds of labour productivity growth in 2000-2007. Worse still, this regulation would drive the whole industry overseas, taking many jobs with it.”
London’s strength makes UK more sensitive to financial shocks than other Member States. The findings also show that the UK’s strength in financial services makes it more sensitive to both positive and negative shocks. In the worst-case scenario, the UK’s financial services industry is hit harder than other major EU financial centres, with GVA in 2012 19% below 2007 levels in London compared to -14.3% for other major EU centres. However, London also stands to gain the most from a recovery: in the best-case scenario, London’s financial services sector would enjoy a rebound to 17.8% above 2007 levels in 2012, compared to 13.4% for other major EU financial sectors.