Prashant Balepur, senior vice president of corporate strategy and partnerships, recently participated in a Canadian Lenders Association (CLA) webinar titled "How to Price a Loan." Balepur was joined by Geoff Finnie from BMO, Sundar Ramanathan of First West Credit Union, Sadeq Safarini from Vector ML and moderator Paul Sy of Transunion.
The focus of this webinar – pricing credit products – is an often overlooked, yet crucial aspect of the lending business. Mispricing can often lead to outsized risk, poor capital efficiencies and drag on margin and volume. Among other things, the panel discussed the components of a successful pricing strategy as well as how different Canadian lenders approach pricing.
Here are some of the key takeaways from this discussion:
Price is how "value" is expressed and exchanged – in both directions.
While there is no single formula for determining a successful pricing strategy, it does follow a basic structure. Pricing a credit product is a value exchange between the financial institution and the borrower. You as a lender evaluate borrowers for credit worthiness and price accordingly. Similarly, in competitive markets, borrowers evaluate you based on your price, convenience and brand relative to your competition. So, understanding a borrower’s needs, preferences and quantifying their willingness-to-pay or price elasticity is just as important as understanding credit risk or costs.
Pricing includes several moving parts for which banks must account.
It is important to note that there are roughly 11-14 components that need to be considered when building a pricing strategy and setting a price. It’s also important to apply all of the relevant components to a borrower and their application to ensure a full and holistic view of the borrower. This ensures all necessary and relevant information is being used when setting a price.
Many small to mid-sized financial institutions start the pricing process by evaluating the market being served. By finding the right value proposition and profit model in the market being served, these banks and credit unions can determine how they compare to local competition. For small to mid-sized financial institutions, a common practice is to set a base price based on funds transfer pricing (FTP) and then add value on top of the base price. The question then becomes whether the bank or credit union is pricing this product for profit or market growth. Not every financial institution will have the same goals, and the answer to the question could even change from product to product.
For bigger banks, many of the same pricing principles apply, as each bank sets out to understand its core profitability to then add value to the price and manage its margins both at the transactional and portfolio levels. By taking a holistic approach to pricing and looking at the life cycle of the loan from origination to account management, larger banks have the ability to build pricing strategies geared towards optimizing profit based on price sensitivity.
Effective pricing is personalized and holistic.
An important factor to consider when determining pricing and the value exchange is that you are not just pricing a single loan. You are pricing a relationship with your customer. So, it’s important to account for relationship value holistically, looking beyond the immediate transaction to the entirety of the relationship. Some institutions are able to take that to the next stage by looking beyond a customer’s relationship today to the relationship’s potential tomorrow.
Conversely, from a portfolio management standpoint, multi-product institutions need to look at pricing across all their products together v. in isolation, especially those that are potential substitutes in a customer’s borrowing decision. How does your unsecured loan compare with your home equity line of credit (HELOC)? And how does that compare with a cash-out refi? New entrants like BNPL add another degree of complexity to this analysis.
Pricing is increasingly being solved by data-fueled, ML/AI platforms.
Leading institutions of all sizes are using ML/AI-based pricing systems to automate and optimize pricing decisions. Modern pricing platforms like Nomis’ can help banks and lenders develop and execute test & learn strategies, quantify price elasticity, predict the likelihood of a customer converting and find optimal price points that drive profitable growth. These platforms also dramatically reduce the effort, cost and complexity of executing targeted pricing strategies or complex relationship pricing and offers. Nomis’ customers have realized over 5-30X return on investment by leveraging such data-driven approaches.
Finally, don’t forget the other human element – your frontline.
Even as banking transactions are increasingly digitized, borrowers continue to prefer access to loan officers and advisors for key stages of the transaction, especially for complex products like mortgages. However, when it comes to pricing – a critical step in the sales process – your frontline is often poorly equipped, straddled with manual processes and consequently more price sensitive than your end customers. Modern platforms like Nomis help connect back-office decisioning with easy-to-use front-line capabilities. Empowered bankers and lenders are able to serve as true advisors and deliver the product, pricing, offers and experience that make everyone happy.
By leveraging next-gen pricing science and technology, such as the Nomis Platform, banks and lenders are better positioned to optimize rate sheets, discretion boundaries, promotional campaigns and more. Further, they are able to automate back-office price and offer management processes while empowering the frontline through streamlined offer presentment and exception handling.
Contact Nomis to learn more about how our end-to-end pricing intelligence, analytics and execution solution can help you build a successful pricing strategy.