Scotland’s finance sector faces “lost decade” thanks to bank collapses, says Item Club

Item Club reveals extent of slump and says output won’t recover until 2015

Scotland’s finance sector has been condemned to a “lost decade” of zero growth as a result of the near collapse last autumn of its two largest banks, RBS and HBOS, according to one of Scotland’s most influential economic think tanks.

The dire prediction came from the Ernst & Young Scottish Item Club which, in its closely watched annual forecast for the Scottish economy, today reveals an unexpectedly sharp slump in the output of Scottish financial firms.

Using figures from the Scottish Government’s quarterly GDP series, the EY Item Club said output from the Scotland’s finance sector slumped by 8.4% in the year to June 30, 2009.

The collapse in gross value added was 10 times more severe than the 0.8% fall in financial services output across the UK as a whole.

The City of London has recently been experiencing a mini-boom as a result of rallies in the equities and bond markets thanks to the UK Government’s quantitative easing programme, but these have largely bypassed the sector in Scotland.

The output of Scotland’s finance sector slumped by 6.6% in 2008 and is expected to fall a further 6.7% in the current year, according to the Item Club.

Dougie Adams, economic adviser to the club, said it will be 2015 at the earliest before the peak output of 2007 can be replicated. “It’s almost a lost decade,” he said.

“It’s the nuts and bolts of banking that we do here in Scotland, and that’s obviously hurting because banks are making fewer loans or else they’re pulling in loans. All that kind of activity is down, which feeds through to GDP but doesn’t necessarily feed through to numbers of people employed.”

Employment in Scotland’s finance sector has fallen less sharply than many economists were expecting last year. Total financial services employment has shrunk by 4.5%, compared with a 5.8% fall in employment for the UK.

Adams said job losses have been “less savage than expected”. However, there are thought to be further job losses in the pipeline from RBS and Lloyds Banking Group. He added: “The lingering concerns that the process of rationalisation is yet to get into full swing have been confirmed by a number of recent announcements.

“Clearly, a lot of the headquarters-related functions of HBOS will be under threat and the fact we’re not exposed to the sexier parts of banking like ­investment banking may have ­actually been a negative, given that these have shown something of a recovery in recent months.

“The positive spin is that Scotland has a lot of the bank ‘plumbing’ activities which are likely to stay here, whoever ends up owning the banks.

“While a semblance of normality is returning to the asset management and insurance segments, the future shape of the banking industry remains in considerable doubt,” said Mr Adams. “However, Scotland’s core of skills in the sector may hold out the prospect of relative stability of employment as the dust settles.”

The decline in Scotland’s finance sector compares to declines of 3% for distribution and hotels, 8.4% for business services, 10% for manufacturing and nearly 12% for construction over the same period.

The E&Y Scottish Item Club expects the Scottish economy as a whole to shrink by 4.9% in 2009, compared to a fall of 4.6% for the UK. In overall terms, Adams said the fall in Scottish output is “considerably worse than the loss of output in 1980, though the collapses in manufacturing output are similar.”

The E&Y Item Club warned that the chances of a “V”-shaped recovery for the Scottish economy are now minimal, and predicts anaemic growth of 0.7% for 2010 followed by a 2.1% rise in GDP for 2011. Mr Adams warned, however, that the nascent recovery is at risk of being knocked sideways by the “headwinds of public sector retrenchment. The real public sector squeeze won’t get going until well into 2011.”

Scotland’s finance sector dysfunctional

He added: “The financial system is not functioning as normal. The restricted supply of finance to companies, particularly SMEs who cannot tap the capital markets directly, will act as a brake on the early stages of recovery.”

Owen Kelly, chief executive of industry lobby group Scottish Financial Enterprise, who, along with SNP government ministers, has consistently downplayed perceptions that Scotland was disproportionately affected by the crisis, said: “It has become very clear in the last two years that we were seeing levels of activity, in a number of areas but particularly banking, that were unsustainable and did not reflect underlying economic reality.

“So comparisons with the peak levels of that period will necessarily be negative. But Scotland’s finance sector is diverse and is succeeding in many sectors in what remains a tough business climate.”

First Minister Alex Salmond said it is “nonsense” to suggest that Scotland is suffering a deeper recession than the rest of the UK.

In a recent parliamentary answer, he said: “That is simply not true. From the first part of 2008, when the recession started in the UK, the decline in Scottish GDP is slightly less than that of the UK as a whole. I don’t claim that as a triumph, because it is the sharpest decline in living memory … With the sole exception of financial services – for understandable reasons – much of the Scottish economy is proving incredibly resilient.”

A Scottish Government spokesman insisted the country’s financial sector retains real strengths, especially in pensions and asset management, adding this was reinforced by recent job creation announcements from Tesco Bank and esure.

He said: “A thriving financial services industry is an important element of the Scottish economy. As highlighted by our National Conversation paper on supporting business and enterprise, independence could help us deliver greater growth in the long term across the Scottish economy and act more comprehensively to combat the downturn in the short term. In particular, a more competitive, transparent and efficient tax regime would benefit businesses in all sectors – including financial services.”

This article was published in the Sunday Herald on 28 November 2009