Our external environment
We operate in an increasingly dynamic market and have to respond to an ever-changing external environment. We've built our business and our strategy to manage the fluctuations we see.
- Given our focus on UK customers, the Group’s prospects are closely linked to developments in the UK economy.
- The UK outlook deteriorated in the second half of 2022, heavily influenced by the invasion of Ukraine and central banks’ response to high inflation.
- High inflation and rising interest rates create a challenging UK economic outlook for 2023.
After starting 2022 with economic activity constrained by COVID-19, UK GDP recovered almost to its pre-pandemic level by mid-year. Further recovery was limited by rising numbers of workers with long-term sickness and weak productivity growth. House prices and commercial real estate (CRE) prices continued to rise through the first half of 2022. During the second half of the year, however, Russia’s invasion of Ukraine began to have a large impact on global and UK economies.
Higher energy and food prices exacerbated greater supply chain costs, pushing UK CPI inflation to a 41 year high of 11% during the fourth quarter. Although the UK Government capped energy prices and provided further support to lower income households and pensioners, households’ spending power fell by around 2% in 2022, the largest single-year decline since the 1950s.
Policy support to counter cost of living pressures is constrained. UK Government finances are increasingly stretched, entering the third economic ‘crisis’ since 2008. Spending plans for the next five years have been pared back, taxes raised and the energy price cap reduced from April 2023. In response to inflation rising well above target, the Bank of England raised UK Bank Rate from 0.25% at the start of 2022 to 3.5% by year end, the highest level since 2008.
Although inflation will begin to fall from early 2023, this is expected to be gradual, causing a further decline in households’ spending power, dragging down UK GDP by 1.2%. With UK Bank Rate expected to be 4% through most of the year, house prices are forecast to fall by 7% across 2023 with mortgage affordability for new buyers at its tightest since pre-2009. Higher interest rates are reducing CRE prices even more significantly.
There are significant risks to these forecasts in both directions – the impact of rising interest rates could weaken the global or UK economy more than expected; conversely, the cost of living squeeze may be not as deep as assumed if recent falls in wholesale-market forward energy prices persist.
Developments in our markets across 2022 reflected the recovery in economic activity from pandemic-restricted levels of 2020/21, the end of government schemes that had supported companies’ borrowing during the pandemic, and the rise in inflation. Consumer credit market balances rose by 5% as spending recovered, although have still regained only half of their fall during the pandemic. Mortgage market balances rose by a healthy 4%, supported by the 18% rise in house prices over the three years since the start of the pandemic. Growth in households’ deposits slowed to a more normal 4% in 2022 after having grown by 17% in total over 2020 and 2021 when spending opportunities were constrained. Business lending grew slightly, but this masks a bigger rise in lending to large companies and a fall of over 5% in lending to SMEs as businesses began to pay down COVID-19 scheme borrowing.
A mild recession and falling property prices are expected to reduce growth in most of our markets in 2023. Mortgages are expected to slow the most, as higher interest rates drive down housing transactions. Consumer credit growth is expected to slow less, with further ground to make up to the pre-pandemic level of balances, and with elevated inflation supporting the nominal value of spending. Household deposits growth is expected to slow to its weakest since 2009 as the cost of living squeeze intensifies. SMEs are expected to continue reducing their elevated borrowing.
Given our UK focus, the Group’s prospects are closely linked to the performance of the UK economy. Despite this, our business model and strategy, in particular the strength of our customer franchise, balance sheet and prudent approach to risk, position us well.
In line with our purpose of Helping Britain Prosper and a clear customer focus, we are providing support to those most affected by changes to the economic environment. In addition to the near-term revenue benefits from rising interest rates, our strategy will deliver growth and diversification even in a more challenging macroeconomic environment, improving the sustainability of returns. At the same time, we are accelerating efficiency measures to offset inflationary pressures on our cost base, consistent with our ongoing discipline in this area.
- Stakeholders expect UK companies to play their role in supporting the country and its people in the current uncertain environment.
- Building an inclusive society and supporting the transition to a low carbon economy are core to our strategy and our purpose of Helping Britain Prosper.
- This focus positions us well to support our customers, colleagues and communities, and create value for all stakeholders.
We are faced with political and economic uncertainty both at home and globally. Rising inflation and interest rates, and government spending cuts and tax rises, engender a cost of living squeeze on many people and businesses in the UK.
The focus on climate change remains, with the emphasis now on companies’ tangible short and medium-term plans and implementation of these plans to support the transition of the economy towards net zero. There is also an emerging focus on nature and biodiversity, the need to protect them and to better understand their inter-linkages with climate. At the same time, increasing regulatory focus on climate risks and evolving sustainability reporting standards put pressure on UK companies to continually enhance their climate capabilities and sustainability reporting.
Core to our purpose, Helping Britain Prosper, and strategy is our focus on creating a more inclusive and sustainable future for people and businesses. This focus positions us well to support our customers and the broader UK society during challenging times, whilst continuing to support the transition required to reach net zero.
In 2022, we contacted over 200,000 mortgage customers to provide support in context of rising rates and more than 550,000 commercial clients to offer support in maintaining financial resilience through the cost of living challenges.
We have also supported our colleagues by providing one-off payments in August and December 2022, and designed a new pay deal for 2023 to provide protection and certainty to our lower paid colleagues into the new year.
We have provided access to quality housing by supporting £2.1 billion of funding to the social housing sector and lending £14.3 billion to first time buyers in the year. We have partnered with the UK Urban Futures Commission and supported local, green infrastructure projects to support regional development across the country.
To support the transition to a low carbon economy, we have provided over £13 billion of green and sustainable finance to businesses and households to help them on their net zero journey and invested around £12 billion in climate-aware strategies through Scottish Widows during 2022. We have also created a new partnership with Octopus Energy to support retrofitting of the UK housing stock and developed our first Group climate transition plan which highlights the progress against our net zero ambitions and the actions we will take towards transition. This plan is included in our dedicated environmental sustainability report as we continue to enhance our reporting on environmental risks and opportunities.
Tax is also one of the ways in which businesses contribute to the societies in which they operate, and we are proud to be one of the UK’s largest tax payers, helping finance public services.
We will continue to work hard to deliver on our purpose, Helping Britain Prosper, by creating a more sustainable and inclusive future for people and businesses, as we believe that it is only by doing right by our customers, colleagues and communities that we can create value for all stakeholders.
- We operate in an increasingly digital market, with potential for new business models and changes to financial services infrastructure.
- Technology investment remains important to improve customer experience, unlock efficiency savings and utilise the full potential of data.
Recent years have seen an increase in customer digital usage as COVID-19 restrictions have accelerated existing trends. Whilst there has been some rebound, with cash usage increasing in 2022 and the share of consumer spend online declining from lockdown peaks, the long-term trend towards increasingly digital‑first financial services remains. Reflecting this reduced customer demand, the number of bank branches continued to reduce during 2022.
We operate in a highly innovative market with business model innovation enabled through new digital technologies such as cloud hosting and API connectivity. Across many markets, there is potential for embedding lending, payments and insurance services within digital, non-financial services settings to disrupt traditional business models. Other areas of innovation such as cryptocurrencies experienced high volatility over the year. Nonetheless, the consequences of digital innovation in payments may be longer term, with central bank experimentation with their own digital currencies gaining pace. This has spurred industry exploration of the potential of technologies like blockchain in areas such as international payments, trade finance and market infrastructure.
As customers increasingly use digital channels within financial services and lead more of their lives online, the potential for fraud increases. However, the first half of 2022 saw a reduction in total fraud volume, following rises in recent years. Technology investment in capability to detect and prevent fraud, in addition to regulation such as secure customer authentication, is beginning to tackle this important issue for customers.
More broadly, the potential of new technologies to simplify legacy systems remains for banks. This includes reduced run and change costs, and improved services provided to customers enabled through real time and fully contextual data insights.
The Group continues to see significant value in its all-channel distribution model, maintaining a wide branch footprint alongside digital capabilities, which are critical to driving revenue growth and diversification for the business. Experience in 2022 has only enhanced our conviction of the importance of our technology transformation program for the long term health of the business.
In 2022 we have increased digitally active customers by 8% to 19.8 million and continued to invest in simplifying our technology estate, making good progress in re-platforming our businesses and achieving a 5% reduction in legacy applications. This unlocks customer benefits, such as faster, more seamless digital journeys, and business benefits through a lower cost to run and enhanced technology estate.
Our investment to maximise the potential of people, technology and data continues. During 2022 we reorganised our teams to bring business and technology ownership closer together through a new platform-based operating model. Our investment in data continues to mature, supporting better customer and business outcomes, in addition to enabling the deep customer insights required to comply with the upcoming Consumer Duty regulation. We continued to make good progress in transforming our technology and reduced our data centre footprint by 10%.
- We continue to largely operate in mature, highly competitive markets.
- Fintechs are challenged by rising interest rates impacting funding availability.
- Technology companies and international banks continue to expand financial services participation in the UK.
The UK financial services sector is a highly competitive market, attracting new entrants in recent years from international firms and new start-ups backed by private capital. Our traditional peers have been strengthened by rising interest rates, albeit the uncertainty over the economic outlook presents downside risks. Notwithstanding, improved financial strength positions incumbent banks well to compete with new entrants.
2022 saw continued market entry from international peers with the launching of digital-only brands and acquisition of existing wealth management firms. These new direct competitors are expected to broaden their offerings over time in a bid to reach profitability and scale. Other new entrants pared back growth ambitions in the UK, reflecting the need to focus on their core franchise. In addition, technology companies’ extension into financial services has continued. Provision of financial services embedded into platforms, often beginning with payment services, and then extending into working capital or consumer loans and deposits, is a key development. Differing approaches are being adopted by these platforms, from building out their own financial services offerings to partnering with existing banks to provide financial services.
For some UK fintech entrants 2022 was a more difficult year. Following global interest rate rises, increasing funding costs are challenging models that are better suited to more benign economic environments. Valuations and private capital funding have fallen over the year, as expectations of future growth have tempered, and funding costs increased. Nevertheless, the digital experience for customers and speed of execution continue to raise customer expectations across the board, requiring ongoing investment to keep pace, and fintechs remain significant competitors.
We are well positioned to continue our market leading position across multiple markets and deliver on our ambition to grow. We have a strong customer franchise and core capabilities including credit decisioning and market leading efficiency, which is increasingly important given inflationary pressures. Our financial strength allows us to support our customers and our clear purpose and mission drive focus throughout the organisation to achieving our strategic goals.
We have strong customer relationships, meeting the needs of 26 million customers. We will continue to drive strong customer engagement through our multi-channel model and deepen customer relationships through a comprehensive offering. We are increasing our focus on customer segments, building out a compelling mass affluent proposition over time, supported by the acquisition of Embark that completed in early 2022. Our multibrand strategy allows us to compete effectively in intermediarydriven markets, where we have headroom to grow as we improve our capability with technology investment, particularly in our pensions and protection businesses.
We continue to invest in front-to-back digitisation of our SME bank, responding to changing client needs and enabling us to meet more of their needs beyond banking.
We have also increased our focus on collaborating with fintechs during the year to broaden our product capabilities, for example a partnership to enable digital invoice financing and factoring for our SME bank clients.
Finally, within corporate and institutional business we are focusing on our core strengths in cash, debt and risk management products for our UK clients. We will continue to invest in these strengths and scale our originate to distribute capabilities to support clients’ long-term needs and increase our balance sheet efficiency.
- The UK financial services sector is expected to remain highly regulated.
- High volumes of new regulation and market reviews continue to be issued, with further regulatory changes anticipated.
The UK financial services sector remains highly regulated with significant regulatory reform anticipated in 2023, including the implementation of the Edinburgh Reforms, the Financial Services and Markets Bill and reforms to Solvency II. 2023 will see a number of consultations and calls for evidence across the different areas of reform. We will analyse the proposals and work closely with the regulators and the government as and when the different areas of reform are consulted on. Key areas of focus for 2023 are below:
Customer treatment: Fair treatment of customers remains a priority for the FCA, and the introduction of the Consumer Duty in 2023 will require a more outcomes focused approach to prioritise customers’ needs. Customers are facing increased cost of living pressures and we recognise the need to do more to support all customers, including those who may be in vulnerable circumstances.
Capital regulation: The Group complies with capital regulations covering the assessment and measurement of capital resources and requirements, including risk-weighted assets. In November 2022, the PRA published a consultation on its proposals to implement the final Basel III reforms. This included a number of significant changes to the calculation of risk-weighted assets. We are continuing to work closely with the industry and regulators to understand the implications.
ESG: Engagement continues with all key stakeholders, including customers, government, regulators and the market, to help create a more sustainable and inclusive future for all. We continue to enhance our sustainability reporting, including aligning to the recommendations of the Task Force for Climate-related Financial Disclosures, closely following the evolving sustainability reporting standards and requirements, and will further embed climate risk into risk frameworks and policies.
Solvency II: The Solvency II regime which regulates the insurance capital required for insurance entities is currently being reviewed/ is under consultation by the PRA.
Financial Services and Markets Bill: This Bill is designed to map out the future of the UK’s financial services sector following the decision to leave the EU. By tailoring regulation to the UK market, its intention is to increase the UK’s competitiveness as a global financial centre whilst maintaining high regulatory standards to protect customers. The Bill is a wide-ranging piece of legislation that covers multiple areas including reforms to capital markets and addressing customer challenges related to access to cash and fraudulent activity.
Ring-fencing: Since 2019, the Group has been structured into sub-groups to comply with the ring-fencing rules. The UK legislation was passed after the financial crisis to better protect customers and the day-to-day banking services they rely on. We await government’s consultation on near-term reforms of ring-fencing, and will continue to work closely with the regulator on the matter.
Edinburgh Reforms: On 9 December 2022, the government launched the Edinburgh Reforms. The reforms focus on reviewing, updating or reforming a number of areas of financial services regulation, ranging from ring-fencing, consumer credit and the Senior Managers and Certification Regime, to repealing areas of EU regulation now that the UK has left the EU.
Other: A number of other regulatory initiatives are in progress which seek to address, amongst other things: access to cash, mortgages and green financing, culture, operational resilience, completion of IBOR transition, financial crime and accounting (e.g. IFRS 17).
As a Group we always seek to comply with all applicable regulation and engage with regulators on all aspects to improve outcomes. Given the Group’s customer-focused, sustainable and low risk business model, it is well placed to meet these requirements and welcomes the positive effect they have on the industry, its customers and other stakeholders.
- Customers value convenience and relevance for their financial needs; our strategy seeks to meet this through investment in our business.
- Cost of living is forefront in the minds of our customers; we are proactively supporting them in a challenging period.
2022 has been a challenging year for many of our customers. Whilst the social and economic consequences of COVID-19 continue to be felt, the Russian invasion of Ukraine in February added to the economic headwinds from nearly two years of disruption.
New working patterns continue and worsening health outcomes are reducing labour force participation. Supply chain disruption, in addition to global fiscal and monetary stimulus has contributed to inflationary pressure as customers revert to pre-COVID-19 norms. The digital acceleration experienced over the last two years as COVID-19 forced new behaviours has stabilised, with customer activity still strongly skewed towards digital channels. Consequently, customer expectations of convenient, personalised experiences through digital channels remain high.
Rising interest rates in the UK, worsening following the market dislocation resulting from the September mini-budget, had a significant impact on customer and client borrowing costs. Rising mortgage costs have been an unexpected shock for many and the full consequences of this are likely to be felt over the coming years as our customers come to the end of their fixed rate products. Inflationary pressure on real incomes will also have knock-on impacts on longer-term challenges our customers face, such as saving for retirement. Businesses face a combination of rising input costs, higher borrowing costs, a tight labour market and lower consumer demand. Whilst government intervention in energy markets has softened the blow on customer finances in the short term, rising taxation on both consumers and businesses presents a challenging outlook.
The Group continues to adapt to customer trends. In the longer term, to meet customer expectations for seamless, personalised experiences, we continue to invest in our data and technology capabilities. The benefits of this can be seen in our cost of living support hub; our customers have visited this over 875,000 times and received personalised support with debt repayments, subscription management to help control spending and links to independent advice and support services. The cost of living challenges increase the need to execute on our strategy, deepening relationships with customers to support their financial needs and creating a digital mass affluent proposition. For commercial clients, digitising our SME business and focusing our corporate and institutional business on meeting their core cash management, debt and risk management needs remains our focus.
We have increased our support to customers during 2022. Cost of living pressures are affecting our customers in different ways and there are increasing expectations for financial service providers to do more to support them. We are tailoring our support to meet our customers individual changing circumstances and have trained more than 4,600 colleagues to provide financial assistance to individuals and businesses to help them build financial resilience and provide access to tailored products if needed. To support customers with potential financial stress, we have offered over 200,000 mortgage customers support in the face of higher interest rates and provided 220,000 customers a £500 interest-free overdraft buffer. We’ve also communicated to more than 550,000 businesses to provide support and options in managing their finances, for example sustainable financing options to reduce energy costs. Our digital strength is also supporting customers to take greater control of their finances, with over 5 million registrations for our Your Credit Score tool.
Our strategy and purpose
Our purpose is Helping Britain Prosper. We do this by creating a more sustainable and inclusive future for people and businesses, shaping finance as a force for good.
Risk management is at the heart of our purpose. A prudent approach to risk is fundamental to our business model and drives our participation choices, whilst protecting customers, colleagues and the Group.