Aggressive pricing: Is it a Bane or Boon for Banks? 🏦
What is Aggressive Pricing in Banking?
Aggressive pricing is a risk that can make or break a bank. If applied properly, it can increase the bank’s profits. But only used during a radical shift in the banking market. An example was the Santender bank in Spain launched its “Super Account” that doubles the interest rates of their depositors during in the 1980’s when the country is liberalizing its interest rates. It worked and now the bank’s market share has doubled. But this can only be used during an absolute change in the banking market and only the first clients benefit from it.
Aggressive Pricing Could Start a Price War
This kind of pricing strategy could trigger a price war against other banks and destroy their credibility. It must not be used so loosely when banks are losing money or market share. There are other pricing strategies banks must consider first.
Pricing strategies and its application
Pricing strategies and its application in banking have shifted radically from deposit interest rate to digitization age. Banks which traditionally based their profitability on deposit interest rate are finding this is no longer applicable. In the light of recent international bank scandals, customers become wary of where to put their money. Therefore, new regulations that stem illegal activities are in place.
Also, the flourish of digital banks have forced the traditional banks to develop more aggressive pricing strategies in order to retain their clients and attract new ones. We will discuss those pricing strategies here.
Banks are under pressure to find ways to secure fast and sustainable revenue stability. Moreover, there is a growing need for banks to improve their front-line staff support and overall performance, as well as middle and back-office functions. Developing value-based pricing strategies will not only gain leverage against the competition but will help banks to keep their edge in the market.
Procedures such as passing the cost of funding to clientele with an increase in rates are regulated by government agencies to prevent bank frauds. In light of this, clients are finding it easier to open banking rules, websites for product comparisons and enhanced on-boarding processes to find out if the bank is engaged in unfair pricing.
Does Bank Pricing Strategy makes a difference to customers?
With the rise of digital banking, banking executives are finding they need to get their customer pricing right to stay ahead of their competition. Here are the five premises of customer-focused bank pricing:
- Doing what is right for the customer and rewarding loyalty. Of course, the prices must be fair and show the true value of the service or product.
- Setting prices according to customer profiles to find and protect profitable revenue growth. Furthermore, considering factors like the customer value proposition: i.e., things like the willingness of the client to pay and the asset’s risk profile should all be reflected in the full economic value/profit equation?
- Controlling the funding cost. In practice, any bank can find funding to finance loans. However, the real challenge here is finding the right funding without cutting into net interest margin.
- Manage the cost of funding. Banks are now seeking to control funding volume without compromising net interest margin.
- Increase market share. Banks are using more promotions and offers to attract desired client types and products to them. These offers and price are commonly optimised to ensure they protect their margins.
- Understanding client types or profiles: Banks are paying more attention to why and how people buy from them to give the bank an edge. They are now offering preferred client segments tailor-made offers that suit the needs of their client base. Whether this is: waiving fees, frequent-flyer points or interest rate discounts on loans and mortgages.
Now, unlike any time before, banks are taking a more agile approach to pricing. They are keeping their edge and thinking of their long term pricing strategy execution. This means constantly revising their pricing and incentives to gain new customers and reward loyalty.
Technology has provided the banks’ real-time analyses on customer data and techniques to give the opportunity to try out dynamic pricing methods and segmentation. They can now assess the profile of the customer – including the amount of risk the bank is willing to give. Not only will can banks now gain profits with their bank pricing strategy, they can also go after the right customers and know what loans they can afford to pay before they do.
The essence of strategic planning is that banks can refine any fees paid by their clients and give them personalised rates based on their specific banking profiles. For instance, they will give incentives to a particular client in order to give them the increased saving capacity they want AND to also to gain their loyalty as well.
Strategic pricing for banks is tied up in a dynamic pricing structure. A pricing structure based on the relationship the bank has with its clients. What’s more, strategic pricing for banks comprises two parts:
- Strategic pricing – this strategy is more focused on client demand and not on the product. That’s to say, it requires a purer form of dynamic pricing as well as injections of yield management as demand increases.
- Pricing execution – this shifts from the products as the revenue earner to the clients’ profiles i.e., how they perceive and value the bank’s services and products AND whether it is in retail or corporate banking.
Often, deposit pricing is not included in a corporate strategy of bank pricing. Largely, this is because it is risky to increase bank revenues by enticing their clients from well-funded businesses. To improve this, it needs three scenarios:
Optimal strategy. An optimal strategy is the most fundamental bank pricing strategy. Providing a nominal fee is regulatory for the clients’ bank deposits. Hence, optimising the deposit fee is a strategic tool to utilise. The three models adopted by banks to deposit pricing are as follows:
- Passive followers – whereby customers deposit their money to the bank – without doing any business with the bank.
- Aggressive pricing – Generally used by banks during periods leading up to change. Essentially banks in this scenario will allow a small window of opportunity for all client types to deposit their money.
- Pyramid pricing – This is when banks discount their deposit prices OR use customer deposits for investment to achieve maximum and accelerated returns.
Differentiated pricing in banking focus largely on targeted client acquisition. Not all depositors are equal. With that in mind, banks target cash-rich businesses like entertainment, technology, education and sports.
By combining maximum rates to selected clients, banks can optimise revenues by giving better rates to those who have large cash deposits or potential cross-selling clients. For example, they can offer several volume pricing curves and give big depositors favourable prices.
Cost of funds (FTP) Pricing
Cost of funds pricing is also known as internal or funds transfer pricing. Banks have a basic principle on businesses lending. The cost of funds like loans have track funds – external pricing – whereas liquid loans – like credit cards – have an internal guide to calculate pricing. Basically, the cost of the fund comes from the actual funds obtained in the market.
Relationship-based pricing is another pricing strategy used by banks. This is when the bank decides to set prices based on their relationship with clients. Chiefly, only strategic clients that have a mutual benefit with the bank can avail of special privileges provided by banks offering relationship-based pricing. To be sure, the criteria with relationship-based pricing are those with substantial loan and deposits volume, numerous products on hand, personalised Economic Value Added accounts (EVA) and extra value to bring to the relationship.
As you can imagine, the strength of client relationships with the bank can vary over time and between clients. Hence, relationship-based pricing can vary a lot between different banks. Consequently, differential pricing is often at the discretion of the bank manager who chooses the terms and rates.
IT Systems Essential to Bank Pricing Strategy
All these pricing approaches (listed above) need the support of AI-driven pricing. Hence, IT systems to collect and analyse big data on customer pricing are crucial. In particular, we note that customer-focused pricing in banks requires a lot more formal guidelines. Namely, to ensure prices for lending and saving are in the customers’ favour. These include: actual product costs, client relationships, and projected profits.
How has bank pricing changed over the past few years?
In the past, bank pricing strategy was in the hands of the bank manager. Can you remember the days when it would take months for the bank manager to clear home loan requests…
Well, with new pricing and IT systems, it now can take a matter of minutes to get data on a customer and 2-3 days to get loans approved.
An effective IT system integrates into the bank’s overall database to improve decision making accurately and speed. For example, new IT systems now have unrestricted access to funding costs from the ALM system, client histories, CRM product information, information from the risk management system, and capital costs. Which means that, in a touch of a button, some IT systems can produce the data the bank needs like:
- price options,
- customer importance,
- profit impact
- and negotiation strategy tips.
But an IT system alone is not enough to improving pricing decision making in banks. No, in the background, there’s an established professional pricing team informing and managing pricing structures and operations too.
In particular, a pricing teams mission is very strategic with some critical operational tasks to drive as well: A pricing team is responsible for designing and implementing the new pricing strategy. They also choose the key inputs to integrate within an IT system; and then analyse the output to determine price bandwidths and clearer parameters for their pricing structures. Their remit from here would include things like: pricing policies, review, management, support and guidance.
- The international bank scandals and aggressive pricing in recent times has put a strain on customers’ trust in banks.
- New pricing structures are implemented to attract more depositors and retain customers’ loyalty.
- IT hardware and systems are now integrated within the banking system. Principally, to analyse customers’ banking profile, risk management and new pricing schemes.
- A pricing team informs bank pricing strategy and implements the new rules and pricing strategies required for different products, segments and divisions.
- The old system of deposit rate interest profits is obsolete. Banks are now testing new banking pricing and IT systems to increase profitable revenue growth.
- Competitive measures and aggressive pricing are now being implemented against the proliferation of digital banking to retain customers’ loyalty. That is to say, measures like lower interest, lower deposit pricing and other benefits await the customers if they continue their banking.
- An effective IT system can aid the pricing team in setting the right bank pricing strategy for the bank.
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