Risk-based pricing can be summed up in one word: capital. It is all about the effective and efficient allocation of risk capital to each loan based on the merits of each loan. Loan profitability is often expressed in terms of Return on Equity (ROE) or Risk Adjusted Return on Risk Adjusted Capital (RAROC). Keep in mind that capital is the denominator used in the ROE/RAROC calculation. Therefore, allocating the proper amount of capital to a loan has a direct and significant impact of the profitability of that loan.

PrecisionLender offers a flexible risk-rating system that supports varying levels of risk-based pricing sophistication. These range from a simple single-factor risk rating approach (Borrower risk rating) to a sophisticated multi-factor risk rating system (incorporating any credit risk mitigants such as collateral and guarantees).

The "Risk Ratings" drop-down is located in the middle of the right column when pricing any Opportunity. The default setting (typically "3. Average") and the options within the drop-down are fully customizable and set by your Administrator.
This "Risk Rating" represents the risk grade of the Borrower and is used to indicate the "Probability of Default (PD)" for that Borrower and an allocation of credit risk capital. The higher the PD, the riskier the loan and a larger allocation of credit risk capital is recorded. For a given Risk Rating, the bank has an “Expected Loss (EL)” which is derived as the PD x LGD (Loss Given Default). The EL is recorded as the loan loss provision that runs directly through the income statement of the loan. However, the credit risk capital is there to cushion against Unexpected Losses (UL) and doesn’t get charged directly to the income statement of the loan.
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