Poll: Bankers feel they aren’t pricing loans correctly
Given the current state of interest rates, loan pricing has become extremely competitive and net interest margin has taken a hit at most banks. This intense competition has forced bankers to simply match prices with competitors, not knowing if the loan is priced correctly or profitable for the institution.
During a recent Sageworks webinar, The Real Price of Risk, attendees were asked to describe their current loan pricing strategy/model and how it is applied. While 65 percent of attendees said they are using a standardized loan pricing model, only 35 percent feel they are pricing loans correctly. Of the 65 percent who feel they are not pricing correctly, 23 percent think they are underpricing, 6 percent think they are overpricing and 37 percent aren’t sure.
The main issue with banks underpricing loans, is that they are not correctly accounting for the risk involved with making that loan and not bringing in enough profit to cover potential charge-offs. Higher loan prices allow the bank to put more money into ALLL and augment capital to support risks being taken. On the other side of the spectrum, overpriced loans are charging “good” customers too much, and might encourage them to start shopping for rates at other financial institutions.
During the webinar, Robert Ashbaugh, senior risk management consultant at Sageworks, stressed the importance of a risk-based pricing model to ensure the profitability of each loan. By setting up a standardized loan pricing model that incorporates risk into the price, institutions will safeguard against underpricing loans. Furthermore, a risk-based system will also allow banks to avoid overpricing low-risk customers who have an existing relationship with the financial institution. Having multiple products with the same customer decreases the marginal cost of each product, allowing the bank to give more favorable terms to existing clients.