The quarterly survey of 84 firms revealed a marked divergence in business conditions between sub-sectors, with sentiment holding up among insurers amid a continued expansion in their business volumes. By contrast, volumes were flat or falling for banks, building societies and specialist lenders, while investment managers report the steepest fall in activity since the financial crisis.

The research suggests overall business volumes will fall at a similar pace over the quarter to March, the first-time growth expectations have turned negative since December 2009.

The most important challenge facing financial services firms over the year ahead was cited as macroeconomic uncertainty (59% of maximum score achievable in a weighted ranking of challenges), along with regulatory compliance (26.7%) and preparing for the impact of Brexit (25.3%).

Profits in the financial services sector as a whole remained flat for a third successive quarter, reflecting little change in business volumes and costs. Investment managers and general insurers reported declining profitability. In the three months to March, overall profitability is expected to fall for the first time in over three years, as a result of a more widespread deterioration in expectations across the industry.

Andrew Kail, head of financial services at PwC, said: ‘Continued economic and political uncertainty means last year ended on a more pessimistic note than previous quarters for many working in UK financial services. It is a broad industry, meaning optimism varies between sub-sectors and companies, but this survey shows that investment managers, who have been more immediately impacted by volatile stock markets, are gloomiest heading in to 2019.

‘The underlying reasons for this dip in optimism have been around for some time - political and Brexit-related uncertainty, regulatory pressures and a sustained low interest rate environment impacting margins. Competition from established peers as well as new market entrants is also high on companies' radars.

‘UK financial services firms looking to prosper in 2019 should concentrate on issues they can control. Most importantly, by focusing on clear strategies for delivering value through products and services which meet their customers' needs, maximising the efficiency of delivering these services - keeping operating costs under control - and using technology to augment the quality and efficiency of activities across their business.’

Despite this outlook, firms expect to increase headcount in the quarter to March and investment intentions for the year ahead remain broadly stable. Financial services firms plan to raise spending on marketing and IT at robust rates, and capital spending in other areas is expected to be unchanged. Firms indicated that efficiency and replacement were the main drivers of investment, alongside statutory legislation and regulation.

Separate research from Pinsent Masons suggests technology spending by financial services companies on improving customer interfaces may be coming at the expense of investment in crucial back office IT systems. Analysis by Mergermarket from a variety of public sources of information and company databases shows that just 2% of financial services companies prioritise investment in back office technology, while 77% invest in customer experience.

The law firm points out that Financial Conduct Authority (FCA) research shows the number of IT failures at UK financial services companies has increased 138% over the last year alone to 600.

MPs have also been vocal in urging financial services companies to invest more in back office technology in order to better protect consumers. The call came as part of the launch of an inquiry by HM Treasury into IT failures in the financial services sector last month.

Alexis Roberts, head of financial services and partner at Pinsent Masons, said: ‘Financial services companies can be seriously undermined by underinvestment in the back office.

‘The race to capture market share through customer friendly technology is, understandably, very important but that should not be at the expense of essential architecture.’

Pinsent Masons says the research also shows financial services companies now see acquiring intellectual property or new technologies as the most important objective of M&A activity, cited by 70%, up from 58% over the past three years. In contrast, only 46% see increasing market share as the most important, down from 50%.

Roberts said: ‘Effectively harnessing the power of technology is key for M&A activity and organic growth amongst financial services companies. This is true across the entire financial services sector - not just fintech and insurtech.

‘Although M&A remains a popular method for growth, we are increasingly seeing financial services companies enter into alliances and joint ventures which give them exposure to new technologies without the same commitment as M&A.’

Report by Pat Sweet