Jeff Judy

Jeff's Thoughts - March 22, 2017

On Pricing

At your institution, is credit pricing a proactive decision or just an automatic reaction?

Who determines the pricing for any given credit? In many institutions, the price is determined by a competitor. That is, whoever charges the lowest rates in your marketplace drives your pricing decisions.

But is being a price discounter the best strategy for your credit business? When you follow the competition, does setting your rates and fees become almost an afterthought when all the other details of the transaction are sorted out?

Or do you look at each credit on a case-by-case basis to determine pricing? And what would factor into that kind of case-by-case thinking?

I used to talk a lot, in my training sessions, about "pricing for risk." The idea was that we would charge more for a credit that carries a higher risk that it will not be fully repaid. But since credit risk is often somewhat overlooked when you let the competition drive pricing, it pays to look at it from a couple of other perspectives.

One perspective is the administrative cost of one credit compared to another. In a properly structured credit, your administrative costs of monitoring the credit and reacting to changes in the borrower's situation are a reasonable surrogate for risk. In other words, the less confidence you have in full repayment in a timely fashion, the more frequent financial reporting you demand of the borrower. You may also require other data to be submitted on a regular basis. And all of that takes staff time to log and review (hopefully) to make sure any problems are detected, and handled, early. Credits that demand more attention demand at least consideration of higher pricing.

Another perspective is the profitability of the entire relationship. If your borrower also generates a fair amount of fee income, and helps you with your deposits, maybe you can be more lenient with pricing than you are with a borrower who only generates interest revenue for you. Do you have an explicit profitability model at your institution? Do you have a standard process for evaluating tradeoffs between interest and fee income?

All of this is moot if your staff are not willing to discuss price with the customer. Do your credit staff get explicit training and practice in negotiation to develop their skills for these kinds of conversations? Or are they supposed to figure it out on their own? The more confidence your staff have in their understanding of administrative costs and pricing options, the better they can represent you in discussions with borrowers. And that will become more important as rates inevitably rise over the coming months.

Without that kind of understanding, you may, at best, be leaving money on the table because your staff don't have the skills or the confidence to achieve better rates with your borrowers. And at worst, you may be losing the potential customers your staff practice on as they develop their negotiating skills through trial and error.

Yes, communicating pricing decisions is often less comfortable than other parts of the conversation with the borrower.That is not a good reason for avoiding it altogether. With the right perspective, the right knowledge, and the right training, you can achieve a more profitable credit portfolio than that budget priced competitor across town.