A business case for dynamic pricing in banking

Dynamic pricing is evident in almost every industry. Would this pricing strategy work in financial services? What are the benefits and challenges of a dynamic pricing model?

We are all familiar with dynamic pricing in the hospitality, travel and entertainment industries. We may have even encountered dynamic pricing in e-commerce, probably without knowing it. At its core it is flexible pricing based on current market demands, fine tuned by data analytics where sophisticated algorithms account for time of day, supply, demand, competitive offerings and target profit margins. We have either benefited from – or taken a hit by – what we perceived were bargains or price gouging. Booking a flight or hotel room during peak travel periods, purchasing a ticket to a weekend sporting event or even Uber surge pricing are all examples.

But what about dynamic pricing applied to the financial services industry. Can the credit unions apply dynamic pricing in the same manner other industries have applied it – as an intermediating algorithm, matching supply and demand? Prices of financial services take into consideration operational costs, profit margins, and demand, but at its core, financial service or product pricing is predominantly constructed around risk. A loan, an insurance product, a payment service is usually priced based on risk assumptions.

Let’s focus on a borrower who wants a loan from a bank. The bank will assess the risk of that borrower, and will come up with a rate that is directly linked to that risk and to the bank’s cost of capital, which in turn is based on market based rates. The borrower will, in turn, be very price/rate sensitive, shopping for the best available rate. The only variable in the equation is the bank’s margin embedded in the loan’s rate. The floor on that margin has to align with profitability standards and liquidity coverage requirements.

continue reading »