Myths of Loan Pricing Model Implementation

Based on our work with community banks in implementing loan pricing models, we would like to share with you a number of common misconceptions that we frequently encounter. The first of these myths is the following:

Loan pricing models aren’t for community banks; they are the exclusive purview of large regional or nationwide banks.

Many community bankers believe that using a loan pricing model is contrary to the philosophy of community banking. They view community bankers as making lending decisions based on a close personal relationship with the borrower, and less based on a detailed analysis of the numbers and a strict requirement for a minimum level of return, (a methodology they associate with large impersonal banks in their markets).

Community banks can implement a loan pricing model to manage risks, achieve an acceptable level of return, and assure fairness and consistency in loan pricing without harming the close personal relationships they have fostered with borrowers over time. There does not need to be a strict requirement for a single minimum target rate of return. As a matter of fact, a different level of return should apply to different borrowers, based on differences in credit scores, loan terms, and the other aspects of the relationships they maintain with your community bank.

Use of a loan pricing model may actually improve the lenders understanding and awareness of a borrowers business practices, banking patterns and future financial needs. The model can also serve to strengthen the relationship that currently exists, by explaining the balancing process that the lender manages in striving to simultaneously meet the needs of both borrower and shareholders, in a fair and consistent manner.

Establishing loan pricing policies that are appropriate to your community banking philosophy, and developing flexible return guidelines for a variety of lending situations are just two key implementation areas where Austin Associates can assist you. Implementing a loan pricing model in this manner will increase your net interest margin, and add to overall profitability while still maintaining your community bank culture.

If you would like more information on a best practices methodology for implementing a loan pricing model in your community bank, please contact us today.