Dynamic Pricing in Alternative and P2P Lending

Dynamic pricing in the alternative lending market may be driven by the potential for relationship pricing in conjunction with traditional banking partnerships.

By Pascal Bouvier, Venture Partner at Santander InnoVentures
and Ghela Boskovich, Director, Global Strategic Business Development at Zafin

As a follow-up to our article, “A Business Case for Dynamic Pricing in Banking,” there is a great deal of discussion regarding the role of dynamic pricing in lending and how it may be applied in the alternative lending market. Lending is steeped in risk and every nuance of a lending product is crafted to mitigate that risk. Is dynamic pricing even possible in the alt-lending market?

With the obvious heavy hitters like Lending Club, Kabbage, Prosper, and OnDeckgarnering the lion’s share of attention, there are still approximately 1,300 companies in the US offering services to about 1% of the overall market – one projected to be upwards of USD$350 million by 2025. That leaves the 6,500+ traditional American bank providers fighting for the remaining 99%. Where’s the competition, you ask?

In the banks’ view, that 1% constitutes the “unbankable” or “undesirable” loans. But there is strong evidence that it’s not the retail consumer with bad or no credit history that the alt lenders are going after, but the small/medium enterprise (SME) business customer pool that is the primary, and most profitable, target.

Be it consumer or SME, what makes alt lenders attractive to customers comes down to pricing.

In the consumer market, peer-to-peer lenders like European based Zopa and Funding Circle offer investors (depositors) interest rates typically between 5-6%, attractive to those offered 2-3% traditional bank returns. Granted, borrowers face much higher interest rates (6-33%) than traditional unsecured loan rates from traditional banks (average cap of 16%).

The market sets the price (as do the Central Banks). And no lender is in this for charity – they want a marginal return that covers operational costs, liquidity coverage requirements, and profit. How individual lenders, alt or not, manage their appetite for risk determines a portion of those margins. So, does risk lend itself to dynamic pricing?

Can We Dynamically Price a Single Product?

How elastic is single product price? We’ve asked this question in our previous post, and concluded that relationship pricing is difficult in singularity, but a competitive differentiator and a smart strategy when offerings are bundled. Questioning how the lending market may adapt to adopt dynamic pricing leads us to believe that alt-lenders will slowly start behaving more and more like traditional banks to take advantage of a pseudo-dynamic pricing strategy.

Before we rationalize this assumption, let’s look at two pricing strategies that we predict will play a role in the lending market.

Abandoning Strict Cohort Analysis Pricing: This method of pricing to market segmentation usually means lumping potential customers into a single risk assessment category based on FICO or credit scores. This is the primary factor that determines the price of unsecured risk. Including other factors like age, education, employment and salary history, geography, and potential lifetime earnings, as well as potential repeat lending business to assess risk is a nod to relationship pricing (and lifetime customer value to the lender) that paints a unique profile for each potential customer. With big data and behavioral analytics, the straight jacket of strict cohort pricing loosens up, and pricing inches closer to reflecting the lender/lendee relationship value.

Alt-Lending/Bank Partnerships: While not a pricing option per se, a partnership is a risk mitigation strategy and customer service tactic by banks. It is also a way for banks to bolster their offerings, but the end result is more pricing flexibility. A recent partnership announcement between Regions Bank and alt lender Fundation underscore the advantage to banks:

“This unique agreement….allows Regions Bank to expand loan-product offerings and method of delivery for small businesses while also cultivating long-term revenue and loan-growth opportunities.”

To read the rest of the article on dynamic pricing for lending products, go to the complete article here ...

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