Roadblock: Loan Pricing Models Undermine the Essence of Community Lending
Many community lenders believe that using a loan pricing model contradicts the philosophy of community lending. They view their role as community lenders as making lending decisions based on a close personal relationship with the borrower. Their decisions may not be completely based on a detailed analysis of the numbers and a strict requirement for a minimum level of return. They associate this with large impersonal institutions in their markets.
What to Consider
Community institutions can use a loan pricing model to help manage risks, achieve an acceptable level of return, and maintain 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 institution.
Use of a loan pricing model may improve the lenders’ understanding and awareness of a borrower’s business practices, banking patterns, and future financial needs. The model also can 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.
Setting up loan pricing policies that are appropriate to your community lending philosophy and developing flexible return guidelines for a variety of lending situations are just two key application areas to consider. Executing a loan pricing model in this manner can help increase your net interest margin and add to overall profitability while still maintaining your community culture.
Conclusion
With the information provided in this article series, coupled with your professional experience, you should now be armed with the tools to break through many of the loan pricing model roadblocks. Proper configuration of both the model assumptions and return on equity targets are essential to a successful rollout. By having a firm grasp of the factors that drive the profitability results within your model, your commercial lending team can become stronger advocates and more effective practitioners of your institution’s loan pricing tools and strategies.
Visit the LoanPricingPRO® page to learn more about our strategic loan pricing platform. If you have any questions or need assistance, please reach out to a professional at Forvis Mazars.