Risk-based pricing is a strategy banks use to determine customer risk before assigning interest rates on their loans, whether retail, commercial or wholesale. By measuring the probability that a potential lender will default on a loan, banks can determine whether or not to issue the loan and, if so, the best interest rate possible.
Here are a few of the most important benefits of using risk-based pricing strategies for lending:
1. Improving customer profitability
Determining how much risk a certain customer brings to a banking relationship is integral to ensuring that relationship is profitable. Data Science Central contributor Mousumi Ghosh noted that in order to maintain a higher level of profitability, banks have to determine the value that individual customers bring to the table.
"Banks need to think beyond 'one-size-fits-all' strategy to cater to … increasing [customer] demand," Ghosh wrote. "Banks should look at products and pricing based upon a total customer view and respond to the value that customers bring to the bank across the spectrum of rates, fees, features and services."
By pricing loans based on the total view of all services the client consumes from the bank and the risks involved, banks make better decisions about interest rates and whether or not to extend loans in the first place.
2. Offering bundled package of services to the client
Consumers are becoming more savvy and demanding when it comes to their financial services, and banks are eager to accommodate these needs. Risk-based pricing is essential for mitigating losses and maximizing profits within this landscape.
Specifically, a growing number of clients are eager to create their own product bundles. For banks, offering these bundled services requires a more sophisticated, precise and objective approach. Risk-based pricing strategies, combined with the necessary analytics tools, allow banks to move beyond a limited, siloed understanding of the loan applicant, delivering a more accurate measure of the viability of a grouping of services. Armed with this insight, banks can accommodate the demand for product bundles, remaining competitive in the space while maintaining a high level of capital.
3. Better for the bank
U.S. Chamber of Commerce senior editor Sean Hackbarth pointed out that risk-based pricing offers benefits to consumers and banks alike. These tools decrease the cost of consumer credit in most instances while opening up more options to a broader pool of applicants. This means that banks can pursue a larger number of opportunities while maintaining risk best practices, ultimately improving their bottom lines.
To fully benefit from risk-based pricing strategies, banks must embrace the right tools and resources. Analytics solutions like DealPoint can address risk-based pricing across the enterprise and provide insight into banks' pricing practices. For more information about how DealPoint can facilitate better decision-making across the enterprise and help banks maintain customer profitability, get in touch with the experts at Brilliance Financial Technology today.