The pricing decision for risk assets and deposit liabilities is the most significant variable in the determination of revenues, cost and income for banks.

Consequently, the net interest margin, or NIM, which is the difference between the average lending rate and average borrowing rate of banks, is one of the key ratios closely monitored by the bank’s board, management, regulator, investment analysts and market players.

A slight adjustment in basis points of the interest rate that they charge borrowers or pay depositors, either lower or higher, could have a huge impact on the bank’s profitability. The impact is more pronounced if the pricing decision is applicable to a large pool of loans.

So how do the assets and liabilities committees of banks generally price their loans and liabilities and what factors come into play in the decision making?

Obviously the objective is to come up with a positive NIM. Not much sense of course if you are booking loans at a rate that translates to a negative NIM. But this is easier said than done and typically would entail simulations of a plethora of factors to ensure that you come up with a net contribution that will cover direct and indirect operating expenses.

The most obvious consideration is the market situation, meaning what the competition is pricing for the loan volume that needs to be generated and the deposit levels that need to be sourced. With a rapidly changing market environment, a bank will need to constantly simulate and reconfigure pricing models to determine the right balance of pricing and maturity mix of retail and corporate loans and deposits.

Furthermore, relationship managers are expected to provide a much fuller picture of the bank’s relationship ideally for each customer that could serve as a guide for management to sign off on pricing customer and product proposals. This entails having to consider additional revenue points such as compensating businesses in the form of non-loan related transaction fees, float income from non-interest bearing current account deposits, and corporate floats that can be generated from each customer relationship.

A misstep in the computations could mean a lost income opportunity, an unprofitable relationship or, worse, a lost client.

Then you have the administrative, legal and regulatory compliance related costs that will have to be factored in which in today’s governance environment is quite a heavy and costly task to undertake. All told, these broad range of considerations can have a burdensome toll on the man hours needed to undertake and support a bank’s customer relationship operations.

Current tools for pricing decisions typically are dinosaur-age excel spreadsheets which crank out reports of estimated liquidity flows and funding cost structures but in the end, usually, ALCOs ultimately fall back to intuition.

A new approach as to how banks can price more efficiently, effectively and with real-time accuracy is a futuristic trend that Accenture has theorized and has labeled “Dynamic Pricing.” With the aid of GenAI, Accenture propounds that prices can be readily delivered automatically and customized for each customer, deposit and loan class.

Marketing pitches can be personalized based on the customer’s analyzed granularized database. With highly refined pricing strategies, banks can optimize relationships and give back to customers in the form of promotional incentives, loyalty points, lifestyle and travel rewards which a typical customer will always value, resulting in heightened customer loyalty for the bank.

As an example, they cite Discovery Bank, which tracks customers’ transaction patterns enabling the bank to reduce risk and improve their financial health and then share the value created through personalized interest rates, travel and lifestyle loyalty rewards.

It is South Africa’s leading fully digital bank and has been given a host of awards, i.e, the only South African organization cited by Fortune Magazine in its ChangeThe World list; voted #1 client experience in Ask Afrika Orange index for two years in a row; the Best New Digital Bank in SA by the Global Banking and Finance review; and voted #1 Digital Banking App by the public in the 2023 MTN Business App of the Year Awards.

The bank also provides medical aid administration, life and non-life insurance through its Discovery Health App. In sum, a totally delightful customer experience and enhanced profitability was achieved by Discovery Bank with the use of GenAI.

Until next week… OBF!

(To be continued)

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