Net Interest Income – Beyond the Debate

Duncan Ng'enda, Matthew Krzywicki, Malak Hassaballa

A case for platforms to shore up finances independent of net interest income

Platform operations over the last few years have traditionally generated thin margins, with businesses heavily relying on scale and tight cost control to break even.

18 months ago the outlook was especially bleak; net flows plummeted post-covid and consumer duty threatened to place additional pressure on fees. Fast forward 12 months and we have seen platforms report significant increases in operating revenue on the back of interest rate hikes – a very welcome reprieve from the challenge of suppressed platform net flows in the current macroeconomic environment.

However, this resurgence of net interest income (NII) earnings has been accompanied by a renewed debate over how much interest platforms should pass on to consumers, culminating in a call for intervention by the regulator this July. As this debate plays out, and regardless of where it lands, platforms may wish to consider using their current position of relative balance sheet strength as an opportunity to address core operational challenges. Platforms that act now will remain profitable and surpass competition with or without NII.

What is interest income?

Typically, investment platforms hold 3-10% of client holdings as cash. The cash is held either to fund fees or as part of the trading cycle. Platforms pass on to clients various rates of interest earned on cash balances, with some paying as little as 0% whilst others pay as much as 3.95%. As the Bank of England’s interest rate rose in the last year, hitting 4.5% in the UK in May 2023, the net interest income platforms earn has had a material impact on earnings and profitability, with our analysis showing an average interest income of 6-30 bps.

Given the average income for most platforms is 15-30bps, a 40 to 100%+ jump in revenue stream is significant and transformational on the overall P&L statement.

Is this sustainable?

While this income is a ‘godsend’ for many platforms, we believe it would be a missed opportunity to not use the reprieve and investment opportunity to address underlying cost challenges and inefficiencies. In addition, we anticipate a couple of threats to the long-term viability of interest income as a revenue stream:

  1. An economic recession bringing interest rates down in a similar fashion to the 2008 crash, and/or
  2. Public scrutiny of the rate of interest on cash balances platforms pass on to clients exerts pressure on providers to pass on a larger share/all of the interest to clients – this is gaining more and more attention as the FCA wrote to platforms this July to investigate cash interest margins.

What can platforms do?

We believe there is a huge opportunity for platform providers to carry out the necessary changes to their cost structure such that, even without the interest income, they will be resilient and profitable. In particular, we recommend the following key actions:

  1. Cost Driver Diagnostic – Establish an understanding of cost drivers and revenue streams to identify overall alignment to strategic direction and improvement opportunities
  2. Organization Optimization – Optimize organizational structure (e.g. spans and layers) and clarify roles and responsibilities (e.g. decision rights) to improve operational efficiency and reduce costs
  3. Maximize Outsourcing Arrangements – Eliminate in-house execution of commodity functions and processes, and ensure existing outsourcing arrangements are utilized to their maximum potential
  4. Operational Efficiency Review – Review and remediate functional and process inefficiencies (e.g. transfers) by adopting established leading practices and implementing modern technology
  5. Application Rationalization – Sunset or consolidate disused or duplicate applications that frequently remain after legacy business or processes are migrated onto more modern platforms
  6. Legal Entity Structure Simplification – Realign legal structures to minimize corporate overhead and reduce costs associated with legacy corporate structures

How can Alpha help?

Alpha has experience working with 90% of UK platform providers and a team of practitioners experienced in cost modelling and transformation. Our rapid 4-week diagnostic can help you better understand your cost structure, carry out industry benchmarking and identify a set of opportunities to pursue in preparation for a more challenging environment.

Please contact Alpha here if you would like to learn more.

About the Authors

Duncan Ng'enda
Associate Director

Duncan is an Associate Director at Alpha with over 10 years’ experience working in financial services across Retail and Investment Banking, Wealth and Asset Management, and Insurance. Duncan specializes in business and technology transformation and has extensive knowledge of the UK platform market, leading projects in cost optimization and digital transformation for several clients.

Matthew Krzywicki
Senior Manager

Matt is a Senior Manager at Alpha with 9 years’ experience working with leading financial services companies to align costs to strategic goals. He has deep cost modeling and benchmarking expertise, and his experience in strategy through execution enables him to bring a pragmatic lens to recommendations and proactively address common challenges.

Malak Hassaballa

Malak is an Analyst within Alpha’s Life, Pensions and Retail Investments practice, with experience in complex transformation programmes within the platform market. Malak has previously supported a major UK platform business undertake a significant platform implementation as a Programme Analyst, playing a key role in helping the project team produce deliverables. Most recently, she has been working on concluding a platform due-diligence exercise (focusing on areas such as operational resilience) to support a client with a BPO arrangement.