Self-Assessment of Pricing and Monitoring Performance Levels
Financial institutions should be constantly monitoring themselves in terms of efficiencies when building a process flow in several critical areas. Focusing on pricing and portfolio management, these two areas act as checks and balances against the decision making embedded in the financial institutions daily activity. Where should we price and after the fact how are we doing? How does your institution measure up when comparing to the three levels of sophistication and efficiency in process flow? What level might you reside? Identifying weaknesses in your processes will provide a road map for future enhancements in these two critical areas.
Pricing and Profitability Process Area
Characteristics of Level 1, 2 or 3
Organizations in Level 1 typically have a reactive, competition-driven pricing strategy. Risk-based financial performance is often below peer averages for loan yields and net interest margins. Management reporting of relationship or lender portfolio profitability is weak or non-existent and the organization will struggle with attempts to rank clients or loan officer portfolios. Tools and/or data to guide lenders in the pricing of loan requests is usually not available and profit indicators for the loan committee are not part of the Loan Submission Package.
Organizations in Level 2 typically provide some basic form of analytical pricing tools to lenders, usually omitting risk-based considerations. Models in use tend to oversimplify, and possibly misrepresent, cost assumptions. As tools are not proven, many doubt their reliability. Loan structure simulations are absent or underutilized, and lenders have no means to conduct pre-call relationship profitability analysis. Integration to pertinent databases is generally lacking including links to performance measurement.
Organizations rely upon results across the organization have entrenched these factors in the Loan Submission Package, enabling profit-aware sales strategy. Lenders leverage the model to conduct profit simulation calculations and pricing and accumulated profitability results can be used for officer re-validation of model factors is critical to insure indicators are consistent with entity level direction and financial performance. Integration of model logic with other key risk, accounting and ALM measurement policies in Level 3 are able to allocate costs and possibly economic capital to product lines. Their tools include a risk-based component for credit and market risks. Profit analysis can be conducted for multiple products at the relationship level and relationships can be ranked by risk-adjusted profitability. Model validation periodically is highly recommended.
Portfolio Management Process Area
Characteristics of Level 1, 2 or 3
Loan Administration Departments for organizations in Level 1 typically lack an identifiable structure. Processes are poorly defined and/or not standardized, leading to a lack of accountability. Tracking systems are manually based, often fragmented, and compilation of reporting information is difficult and time-consuming. Compounding this, data integrity of often an issue.
Organizations in Level 2 typically have a ‘partially’ centralized structure, with some standardization of processes, often localized on a departmental basis. Tracking systems are manual or home-grown and managed by lending or loan administration. Management reporting capabilities are limited and data integrity remains an issue.
Level 3 organizations boast centralized credit administration and loan operations departments typically operating as separate units. Compliance and accountability are improved along with reporting capabilities, aided by better integration with core accounting systems. Data integrity is good. While processes are well established and consistent, separation of units limits ability for even tighter integration of lending processes.
Did you identify your financial institution at one level, or perhaps somewhere in between? The key is to identify and validate the weaknesses in the process flow and then embark upon shoring up that process to provide management the information needed to become more efficient and more informed in these two crucial areas.
Posted on July 3rd, 2019 at 11:21 am
Topics: Pricing & Profitability
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