Risk-Adjusted Loan Pricing

Abstract

We analyze what are the main pricing components for performing loans. By exploiting a survey conducted by the authors in AIFIRM (2021), we provide empirical evidence about whether and to what extent various pricing criteria are related to interest income within the internal model framework. Our main findings are that banks’ interest income is positively related to the adoption of advanced internal risk-based models, the calculation of the break-even rate, and the implementation of the risk-adjusted profitability measures in the pricing, while it is negatively linked to higher market competition, a decentralized pricing function (allowing more customeroriented loans prices). The results make urgent to monitor and develop improve current risk models to support both central offices and the sales network in the process of formulating loan prices and monitoring the value consequently created.