Risk & Relationship based Pricing Part 3.1 – A simple quiz.

Before we dig into our pricing principles, I’d like to propose a very simple pricing exercise.Imagine you are the bank’s new business officer. You have to recommend one and only one loan. Which one will it be? The bank is short of equity following Basel III, so cannot take both but would be ok with a certain portion of both, say 80% A and 20% B or vice versa.

Client A
Loan type Annual fixed instalment
Credit Rating 2
Loan Amount € 150,000
Maturity(years) 20
All-in Rate 4.79%

Client B
Loan type Annual equal reimbursement
Credit Rating 3
Loan Amount € 150,000
Maturity(years) 4
All-in Rate 4.78%

Other elements you are given before you can make any decision are:
1. The prospect borrowers have been scored and rated as 2 and 3 (on a rating scale of 1 to 10, with 1 being the best).
2. The current Yield Curve for risk free interest rates, from 1 year to 20 years is as follows:

YC pa in %
1 year 3.35%
2 years 3.45%
3 years 3.75%
4 years 3.85%
5 years 4.00%
7 years 3.95%
10 years 3.90%
15 years 3.75%
20 years 3.50%

3. The bank is under huge stress to maximise profits because it needs to attract new capital and compensate the huge costs it has been faced with following the latest large compliance investments and liquidity crisis.
So, which one will you recommend for financing by the bank, Client A, Client B or a mix of both?
Send me a word (cw@bamkstrat.com) or give your opinion through the LinledIn.com poll!

I’ll give you the answer in a few days.



April 3, 2013 · 9:25 am

2 responses to “Risk & Relationship based Pricing Part 3.1 – A simple quiz.

  1. The issues you describe are spot on to what I experience as a consultant to many consumer banks. We are constantly balancing bank profitability against competitive realities such as the scenarios you describe. The good news is that with the consumers proclivity for mobile (see PwC future of retail banking) where 60% prefer the mobile channel over branch banking, the costs are lower in terms of cost per interaction. This speaks to the ability to price based on the level of interaction required by the consumer. We see that already with more aggressive loan rates being offered by online banks like Ally vs. the rock bottom rates offered by a branch banking giant such as Chase.

    • Thanks for the comment. I agree with you, the mobile bank will be “cheaper” because the operating costs of that channel is so much cheaper than brick and mortar. The product cost should reflect that, but as you point out the interaction between customer and bank can introduce relationship based pricing by targeting focused products (next best buy or product with high sales propensity) based on the information gathered around the customer interaction. Here we are getting into big data… and here big nasty banks have the advantage = deep pockets! I don’t believe big is beautiful but smart is beautiful. hence how can the smaller on line banks replace investment money by an adapted business model, giving them a competitive hedge? There are answers but these will be bank specific and will always require a clear strategic vision.
      Again thanks for the comment.

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