In any business, there is no point in originating transactions that involve a great amount of risk for a tiny return. This holds equally good for pricing loan products by a bank. Bank consideris return on a risk adjusted basis and the expected loss for the capital at risk. Therefore, banks should follow risk-based pricing with an objective of determining the minimum return on new transactions.
Risk-based Loan Pricing and Marginal Risk Contributions
The concept of risk-based pricing requires every bank to consider minimum return of new transactions, in line with the risk undertaken in the transaction, and with the bank’s target return. When considering a new credit proposal by a bank, it should fix its pricing in such a manner that it yields return in line with the target return on capital.
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