Why balance sheet growth isn’t everything: the Net Interest Margins problem

Having a high Net Interest Margin (NIM) is the goal for banks and financial institutions as it is a key indicator of profitability. Increasing NIM is a simple calculation of net income – i.e., the money created through lending money out – compared to the interest paid out. In essence, banks must sell more lending products to be profitable while also delivering suitable products at appropriate prices to meet their consumer duty requirements.

However, the NIM outlook for banks has become more opaque in recent times, due to the complicating factor of heightened interest rates. After an unusually long period of record low interest rates, the sudden spike experienced over the last three years has created some unique challenges.  

To counteract interest rate uncertainty – and maintain profits – banks need to find more creative ways to lend to customers. Yet, despite the urgent need to do so, many banks are struggling to innovate at the necessary pace.  

Balance sheets may look healthy, but could be hiding a nasty surprise 

Rising interest rates have helped to inflate bank balance sheets. In fact, our research shows 70% of banks have seen the total value of their balance sheet grow in the past 12 months – which is a positive indicator of growth.  

However, it has also put banks’ business models under intense scrutiny. With many customers – mortgage customers, in particular – on fixed interest lending products, there is a lag that banks need to bridge. The scales are tipping, as more money is paid out as savings interest, but is not recouped through income on lending products.  

This imbalance is made more profound due to the challenge of encouraging customers to buy more lending products at a time when interest rates are high. Moreover, as the cost of living increases and money gets more expensive, customers are also at a higher risk of default. This puts a greater emphasis on products’ affordability which adds further constraints on banks’ ability to lend.  

It’s no wonder 77% of banking innovation heads say that the pressure to innovate and launch new products faster has increased over the past 12 months. However, 45% of banking innovation heads say by the time they launch new banking products, they are already outdated, with half (51%) experiencing delays when launching new products.  

These recurring product delays create a vicious cycle for banks which must continuously respond to evolving market trends, but are unable to drive change at a fast enough pace to capitalise on them. Like a swimmer going against the tide, these banks will be left to flounder, unless they can improve their product development cycles. 

Banks need to understand their customers to increase their share of wallet 

Even when banks are able to get products out the door, they will struggle if those products do not resonate with customers. It’s unsurprising that 76% of banking innovation heads say it’s very important or critical to increase the number of banking products or services that each customer takes up. Yet many are struggling to do so. On average fewer than one in four bank customers (23%) buy more than one product from their banking provider.   

Diversification is key to counter this trend. In fact, 80% of banking innovation heads agree that the banks that can’t differentiate their offering will die out. To sell more products, banks need to ensure those products meet a real customer need, and are offered at the right time, in the right context.  

Yet many banks don’t really know their customers or what they want. 90% of banking innovation heads agree they need to understand customers better to stay ahead of competitors, while 85% agree data is the cornerstone of banking innovation. However, data silos, and legacy systems mean many banks struggle to access the data they need.  

The big wins cloud-native technology brings 

To increase NIM, banks need to design and launch timely, targeted and differentiated products that resonate with customers’ desires – and their needs. To do this effectively, banks must completely transform the way they deliver products and services. This change must be driven by improvements to their core banking systems.  

While system overhauls can be scary – and carry significant risk – banks can mitigate risk by adopting a coexistence model, using new systems to build new products while legacy products continue to be run on the old system. This not only allows a more efficient path to market for new products but also provides a proving ground for the new technology. This process also enables everyone in the business to familiarise themselves with new tools, and experiment with the new systems and functionality before the switch-over. 

Better yet, a coexistence model enables a controlled migration of accounts to new technology, removing the risks normally associated with a big bang migration. This approach also helps banks drive innovation. Choosing data-driven cloud-native systems not only enables data to be fed into existing reporting systems but also offers a range of real-time analytics not available on a legacy core to give a much clearer picture of customers, allowing banks to tailor products more effectively. These real-time insights can also be used to meet increasingly strict reporting demands from regulatory bodies – helping to keep banks compliant.  

What’s more, modernisation of the core enables banks to use flexible configurations to create market-leading products featuring multi-currency wallets that meet the demands of modern banking, while also providing the real-time data needed to inform, enable and protect customers. 

Winning the innovation pace race 

As financial uncertainty – and fluctuating interest rates – continue to dictate the way banks operate in 2024, business as usual is no longer good enough for banks looking to increase their NIM, and remain profitable. Instead, banks must prioritise significant improvements to their core banking systems, as it is only through a technological transformation that they can accelerate their product roadmap to launch products at the pace needed to stay competitive.