A Critical Juncture: Lenders' Path to Commercial Excellence

Not a Respite

Earlier this year, we argued that active balance sheet management had become table stakes for UK lenders. Recent months have confirmed that view. Structural hedges now account for over a third of sector NII and are set to grow, cushioning earnings while shifting profitability management to a more deliberate footing.

Latest Q3’2025 disclosures show major UK banks have re-hedged at elevated fixed rates, securing protection through 2026 and, in many cases, into 2027. Building societies, though more discreet in disclosure, have acted similarly. Commentaries from a few CFOs underscores this:

• Barclays: "…the structural hedge is expected to drive multiyear NII growth beyond 2026. For 2027 specially, the yield on maturing hedges is around 2.1%, which remains significantly below the expected reinvestment rate."
• Lloyds: "…the Q3 margin of 306 basis points was up 2 basis points on Q2, driven by a growing structural hedge tailwind."
• NatWest: "… this was driven by further lending growth and margin expansion as tailwinds from the structural hedge and… offset the impact of the base rate cuts in August."
• HSBC UK: “NII growth was driven by the benefit of our structural hedge, an increase in deposits and lower costs of funding, which mitigated the impact of lower market interest rates."

Sources: Barclays, LBG, NatWest, HSBC

Note 1: The scale of structural hedging varies globally, influenced by diverse accounting standards, customer behaviours, legal frameworks, and the maturity of securitisation markets. Additionally, the UK's ring-fencing regime poses distinct challenges for internal financial resource allocation, differentiating it from many international peers.

Note 2: Beneath seemingly stable NII, accounting nuances are at play. Major banks typically smooth earnings volatility through hedge accounting, recognising swap coupons in NII while deferring fair-value movements to OCI. Building societies, conversely, recognise hedge results directly through P&L, leading to a more immediate, and often optically magnified, profit uplift in a declining rate environment.

Far from an effortless gain, the structural hedge benefit is a time-bounded tailwind derived from its 'caterpillar' mechanism of rolling five-year swaps. It is predicted to recede from 2028/29 as maturing hedges are replaced at comparable prevailing yields, assuming market conditions hold. This frames the next three years as a strategic window, not a reprieve.

In parallel, the downward drift in rates is intensifying competition, compelling lenders to hone their commercial strategies and keenly anticipate rival manoeuvres. This dynamic is particularly manifest in retail deposit pricing, a fiercely contested arena where incumbents, mutuals, and niche players vie for position, irrespective of their balance sheet structures.

With a three-year countdown, it would be wise for the C-suite to strategically fortify business discipline, embed client-centric innovation with economic rigour, optimise financial resourcing, and leverage AI for decisive competitive advantage.

The Three Pillars of Commercial Excellence

In response to prevailing market opacity, and drawing on insights from our work with leading financial institutions, we present the Three Pillars of Commercial Excellence, a future-oriented commercial philosophy fusing strategic clarity, operational competitiveness, and technological advantage.

While foundational, the efficacy of the framework lies in its nuanced application across different sub-lending sectors:

• Traditional retail lenders and building societies, with their agile balance sheets, are better positioned to safeguard deposit franchises. Success will come from prioritising granular customer segmentation and proposition design, underpinned by nimble Funds Transfer Pricing (FTP) incentive design to balance the balance sheet. Anticipating policy shifts, they should prioritise swift, cost-effective partnerships with wealth management platforms over protracted self-builds, and upskill staff to retain and manage evolving customer wealth flows.
• Specialist lenders, anchored by deep niche expertise, require precise go-to-market strategies for targeted borrower segments. The winners will combine relationship, bespoke and timely lending solutions, risk-adjusted pricing, and leverage originate-to-distribute funding model for capital efficiency.
• Major banks, given their inherent scale and complexity across diverse geographies, business portfolios, sector capabilities, and capital architectures, necessitate bespoke commercial playbooks. The high-level imperative is to safeguard economic profit by directing financial resources to value-accretive franchises and segments, guided by an adequate management horizon, and by strategically pairing capital-intensive with capital-light services to bolster balance sheet fitness and velocity. It is worth noting that relationship managers remain a decisive human touchpoint for wholesale lending, and enabling their salesmanship is key.

Gaining Competitive Edge with AI

As lenders refine the art of commercial excellence, they are, at the same time, harnessing AI – a game-changing force redefining competative edge. This recent Deloitte Survey highlighted how advanced AI capabilities are shaping the finance function, and the profound implications of Agentic AI for the Future of Work.

Across the UK, lenders are piloting AI at pace, with prominent use cases emerging, from sophisticated market intelligence gathering and AI-driven pricing to conversational data intelligence, and beyond. We highlight the following use cases, tailored to sub-lending sectors.

The true power of AI lies in scaled execution, not pilot programmes. Genuine competitive advantage requires foundational enablers: integrated data ecosystems, AI-augmented tools, continuous talent development, and optimised operating models. Without these, lenders risk technological adoption without strategic transformation, activity without advantage.

The Cultural Pre-requisite

Frameworks and technology may set the stage, but they cannot carry the play. With a three-year countdown underway, an organisational rethink will need to be high on the agenda.

Each function — Business, Finance, and Risk — contributes vital elements to the commercial mosaic today. Business drives customer strategy, pricing, and market engagement. Finance governs ROTE, FTP frameworks, capital planning, and external reporting. Risk manages impairment, appetite, limits, and regulatory and economic capital. Individually, they function; collectively, they rarely compete at their full potential.

The modern landscape, shaped by technology and data, requires core functions to pivot from fragmented decision-making to cohesive, cross-functional governance, enabling real-time calibration of commercial trade-offs across diverse metrics. 

This collective acumen, not individual brilliance, is the prerequisite for Commercial Excellence. For the C-suite, the starting point for reflection is simple: is your firm genuinely well-oiled for it, or stuck in legacy gear?

________________________________________________________________________

The author wishes to thank Shaurya Gupta, Rahmon Ojukotola and Eros Favaretto for their contributions to this article.