Getting the Most From Your Loan Pricing Model
Loan Pricing Model
Banks price commercial loans in one of two ways. They either calculate their loan pricing based largely on what their competitors are doing and what current market conditions seem to indicate, or they make use of a loan pricing model.
Choosing which option to use may initially seem fraught with difficulty. Proponents of trend-based pricing may argue that a loan pricing model is not needed, especially if the bank has a history of success with the trend-based approach. They believe firmly that the market sets rates. Additionally, opponents of loan pricing models may point to the cost of implementing a pricing model and the potential for low return on investment in terms of money spent and time it takes for successful implementation of a loan pricing model.
But is such reasoning valid? What do loan pricing models offer that make them a viable option for banks in a volatile economy?
The answer lies largely with the quality of the pricing model itself. It is essential to remember that loan pricing models are simply tools in the hands of master lenders. As with any tool, for your loan pricing model to work at its best, it must be well-honed and ready for use.
To that end, it is important to note that loan pricing models are only as good as the data upon which they rely. Inputs for your loan pricing model must be as accurate as possible in terms of things like fees, origination costs, and servicing costs. While it is unproductive to get dragged down the rabbit hole of checking and re-checking your programmed assumptions, it is also necessary to occasionally revisit those assumptions and tweak your pricing model as needed.
Additionally, your pricing model must calculate risk correctly. There are several different categories of risk to consider. Interest rate risk, credit risk, and capital risk are all categories which must be accounted for in any valid pricing model. This is an area where a loan pricing model may outshine the trend-based method of loan pricing by a considerable margin.
The ease with which loan pricing models can quickly crunch numbers for a variety of loan scenarios and outcomes enables your loan officers to become more agile in the way they configure loan offerings. While loan pricing models will never replace the skill of your most valued loan officer, they can be used as effective tools in those skilled hands. Providing a framework for decision-making at a higher level, loan pricing models may just be the saving grace for many commercial lending departments.
For more information about loan pricing strategy, please contact us. With years of experience in commercial lending in changing economic conditions, we offer a loan pricing model that is agile, intuitive, and responsive to your market.
To talk more about this, or anything else, let The Hurdle Group assist you.