It’s Time to Take Control of Your Exception Pricing and Become More Customer-centric

The pricing of banking products has gotten more interesting over the last few years, thanks to competitive pressure from fintechs and neobanks, rising customer expectations, greater regulatory scrutiny, and a changing interest rate environment. Banks and lenders are now using several different levers to become more customer-centric in pricing their products.

Base pricing offered to different segments is the first step in driving an accretive pricing strategy. Most pricing segmentations are still largely a combination of product and geography, such as “What should I pay for a 6-months $25K CD in Miami?” or “What is the right rate for money market savings accounts in Fort Lauderdale?”

Over the last three years, we have seen banks increase the granularity of their pricing segmentation by becoming more targeted across product dimensions and geographies (moving from state to metro-area pricing), as well as introducing customer segmentation based on customer characteristics (mass market vs. affluent) or channel (direct vs. branch).

Critical success factors for driving better margin and growth through base pricing include a detailed understanding of demand and price elasticity at the pricing segment level, and the use of constrained optimization algorithms to optimize the tradeoff between margin and volume.

In addition to a sound base-pricing strategy, banks need to implement the ability to execute targeted promotional campaigns and engagement-based products to acquire and retain deposits and loans. These commonly include limited-time teaser rates or special rates for term-bound products like certificates of deposit or home equity lines of credit. Other examples of targeted campaigns: Segment-based promotions for specific markets or customer segments supported by direct marketing, and engagement-based pricing.

Engagement-based pricing, also known as behavioral pricing, rewards customers based on specific behaviors that deepen engagement with the bank. For example, customers have the ability to “earn” a higher deposit rate or other rewards by making periodic deposits into a savings or money market account or using the online app a minimum number of times. There is also cross-sell pricing — a variant of behavioral pricing where banks offer preferred rates or fee waivers to customers who buy multiple products.

A third deposit-pricing tool available to banks is discretionary, or “exception,” pricing. Long used outside the U.S., exception pricing has increased significantly over the last two years as interest rates have increased. For CDs and money market accounts at $100,000 and above, the average frequency of exception pricing is now around 20%, while for business and commercial deposits, the frequency can range as high as 80%.

For most banks, this “shadow rate sheet” is still a closely guarded secret, with a separate finance team owning and managing the exception process. Some banks have started to give some discretion to their front-line bankers and loan officers, usually with a second-line review function, given that close and consistent management of the process is critical.

In order to implement an exception pricing policy and process that optimizes the margin/volume tradeoff while not running afoul of fair banking guidelines, banks should follow these guidelines for success:

  • Establish and enforce rules. If discretion is granted to front-line bankers, it is critical to put process and analytics constraints on the ability to give discretion. A front-line discretion management engine based on empirical data corrects the bias that humans will exhibit when given discretion.
  • Gather data consistently. Most price quotes given to a customer during an exception-pricing process are poorly documented (such as, “match competitor”). This prevents the bank from improving and sharing best practices around pricing exceptions across the bank, and it could pose a compliance risk as well.
  • Have a strategy. Exception pricing is a powerful lever when applied correctly and in conjunction with sound base- and promotional-pricing strategies. Simply giving more pricing discretion because of competitive pressure is not a strategy, it’s a lack of responsible management.

It may also make sense to identify and analyze key trends—this could include the impact of exception pricing on margin across segments, the frequency and severity of exception prices given, and even what constitutes a fair price. Crowdsourcing might be able to help determine what’s fair.

Forward-looking banks are using the three pricing levers outlined above in combination to optimize margins and growth at a time when both are experiencing tremendous pressure. A sound pricing strategy requires a combination of data and analytic insight, systems flexibility to drive engagement and targeted campaigns, and a well-defined exceptions pricing strategy and process.

Frank Rohde, president and CEO of Nomis Solutions, has more than 20 years of financial services experience. He previously served as vice president of enterprise decision management at Fair Isaac Corp.

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