What is Customer Relationship Management and how do we manage

pricing of different product?

CRM stands for Customer Relationship Management. It is a process or

methodology used to learn more about customers' needs and behaviors in order
to develop stronger relationships with them. There are many technological
components to CRM, but thinking about CRM in primarily technological terms is a
mistake. The more useful way to think about CRM is as a process that will help
bring together lots of pieces of information about customers, sales, marketing
effectiveness, responsiveness and market trends.

CRM helps businesses use technology and human resources to gain insight into
the behavior of customers and the value of those customers

CRM is basically a platform where the information about a specific client can be
stored and used any time with in department or with in different department of the
bank.

There is much software for CRM, but all they have a similar functionality.

The process starts are following:

1. Client Information Summary – Here the information about the

prospective client has been entered stored and circulate for further
reference. This is the base of any dealing with the client. This includes
client general information like name, address, contact number, client age,
education details, and if the client is a corporate then can have specific
details like company information, ticker symbol(if the company is listed),
stock price, assets, relation with other banks or any further information.

2. Call Memo – As you start interacting with the client, you need to notice
the details about the conversation for future purpose, so call memo is very
helpful in maintaining the records of the discussion with the clients and
copy to different officers and departments.

3. Follow up Action – As you create one call memo, you need to take
further action for tracking the progress of the work, so follow up action is
required to track that.

4. Client Account Plan - For keeping a record for year wise and product
wise revenue, a specific section can be created where one can keep a
record for the same.

5. Reports - Creating specific reports for maintaining portfolio, disbursement

reports, revenue generation reports for senior management for the
 decision making process that can be very useful if presented in pictorial or
graphical form.

6. Risk Management – For the credit approval process we can use

technology rather than passing credit application on manual basis.

CRM can be user for the 360 Degree Client Coverage System
 Benefits of Using Customer Relationship Management

Information
Management
Client Information
Call Memo
Account Plans
Analyst Reports
Risk Management
Industry Reports & Financial
Product Pitch Analytics
Specialized Reports
Credit Approval
Players Peergroup & Sector
Relationship Manager Analysis
Client Coverage Team Credit Rating
Risk Manager �Quantitative &
Other service/product Qualitative
providers Bank Portfolio
Management
Portfolio Migration Analysis
Financial database for credit,
debt and equity research
Deal Details
�Borrower/Peer Credit
Group Centralized Lifecycle
Previous borrowing database Server Loan Origination
details on Distributed Loan Disbursement
Pricing details network Loan Monitoring
Peer Group pricing Aging Analysis and
Details Loan Loss Provisioning
Collection and Asset
Recovery
 Pricing of Different Products
Purpose
Design for Risk Adjusted Loan Pricing, which includes expected loss
adjustment (i.e. the loss that the borrower may default) and unexpected loss
adjustment (i.e. the loss due to regulatory capital allotted for the facility).

Scope
The new Basel II rules have emphasized the impact of banks’ loan pricing on the
creation/destruction of value for their shareholders and subordinated note-
holders. Hence the required optimal measurement of a bank counterparty risk
make the estimation and pricing of credit risk expedient in the Banking
environment. Risk adjusted pricing and, consequently, of risk adjusted
performance measures, is mainly due to two reasons:

1. The new Basel II capital requirements are directly associated with risk and
therefore it is necessary to correctly estimate the riskiness of credit exposures
to avoid unjustified increase in capital, which will become an even scarcer
resource;
2. Shareholders always expect high returns thus demanding a specific and
focused business policy aimed at value creation

In this document, we have explained the methodology used to estimate risk

adjusted rates and margins for banks’ corporate loans, making use of the same
inputs needed to calculate the new Basel II capital requirements.

In the first section, the loan pricing methodology for different types of
amortizations has been explained. The parameters used in the computation of
risk adjusted return for various types of loan amortizations have been defined.
Also the inputs used to compute the margin and generate the repayment
schedule have been highlighted.

In the second section, the flow of inputs in the user interfaces for the credit
approval process and the generation of margin based on the risk adjusted return
loan pricing model have been discussed.

Finally, in the Appendix we have provided the formulae used in the methodology
applied for the derivation of the risk-adjusted interest rates for corporate loans
characterized by specific repayment plans.

References
• BCBS (2006) (Basel Committee on Banking Supervision - 2006)
• Bank loans pricing and Basel II: A multi-period risk-adjusted methodology
under the new regulatory constraints (Banks and Bank Systems, Volume
4, Issue 4, 2009)
• Pricing risky bank loans in the new Basel II environment (Bank of Finland
Research-Discussion Papers 3 2006 (Iftekhar Hasan – Cristiano Zazzara)
Definitions

• rf = Risk free Rate for different years, are input for the module and are
input by the bank treasury department.(MM)
• PD = Probability of Default on a loan by a client in different periods, is
input for the module and is calculated from the rating module.
• RR = Recovery Rate from a client for different periods, is set using Facility
rating. (MM)
• SC = Required spread on the core capital, that is allocated for the loan
under Basel II regulatory requirements, is input in module from the bank.
• SS = Required spread on the supplementary capital, that is allocated for
the loan under Basel II regulatory requirements, is input for the module
from the bank.
• RCC = Core capital allocated for the loan under Basel II regulatory
requirements, is calculated from Basel II capital requirement and
RCC/RCS, and is calculated in back.
• RCS = Supplementary capital allocated for the loan under Basel II
regulatory requirements, is calculated from Basel II capital requirement
and RCC/RCS, and is calculated in back.
• RCC/RCS = Core Capital/Supplementary capital ratio that is allocated for
a loan by the bank and is an input as a feed from the bank.
• ri,adj = Risk adjusted Return for different periods for a client that must be
used by a bank as minimum return in loan pricing. It incorporates
expected loss (considering probability that client defaults) and unexpected
loss (opportunity cost of the regulatory requirements).
• SEL, I + SUL, I = minimum Spread over rf (Risk Free Rate) that should be
charged by the bank from the respective client.
• RBL = Risk Adjusted return for a Bullet loan (only interest is paid at each
payment date and at maturity interest with the principal is given back in
full) for different periods.
• RCCR = Risk Adjusted Return for Constant capital Repayment (Of the
total loan amount, constant capital is paid back with the interest on the
outstanding amount at each payment date).
• RSLA= Risk Adjusted Return for Straight Line Amortization (of the total
loan amount a constant payment is made that incorporates a part of
interest and a part of principal, at each payment date).
• R (correlation) = Calculated as a part of calculating Regulatory capital, its
formula is taken from BCBS (2006) (Basel Committee on Banking
Supervision-pg 64).
• B (Maturity adjustment) = Calculated as a part of calculating Regulatory
capital, its formula is taken from BCBS (2006) (Basel Committee on
Banking Supervision-pg 64).
 • K = Total Regulatory capital requirement for a loan for a bank and its
formula is taken from BCBS (2006) (Basel Committee on Banking
Supervision-pg 64).
• Base Rate = It is the Prime lending rate that is used by the bank for giving
loan (Banks pricing is in form of Base Rate + Margin), is an input for the
module and is a feed by the bank.
• V= Market Value of Asset of a company
• va= Volatility of Assets of a company
• P= Promised Payment, that a bank need to pay when a guarantee is
called.
• L= Total Liabilities of company
• g(T)= Cost of Guarantee, i.e, percent of the Promised Amount to be
charged yearly.
• Parameters in Repayment Schedule
• Margin(%) = Margin in “repayment schedule” sheet is calculated as
corresponding r (risk adjusted) (either bullet, CCR, SLA, single or multi
disbursed)
• Margin = radj-Base Rate and for corresponding years of maturity
• No. of payments per year= Total number of payments per year for a loan.
• Tenor = Total number of payments in the given period.
• Disbursement Type=single, Multi disbursement
• Payment (Type) = Three types of payment are till now incorporated i.e.
Equal Principal (CCR), Equal Payment (SLA), Bullet Payment (BL).

Definitions of types of Repayments

1. Bullet Loan: It is a type of repayment in which repayments are done at

once in the end or at maturity with whole principle, but at each payment
date interest is paid on the outstanding amount. Hence,
Do= Do* rBL,n /(1+r1)1 + Do* rBL,n /(1+r2)2+…+(Do* rBL,n +Do)/(1+rn)n

where:
rBL,n= risk adjusted return for Bullet payment for n year maturity loan
Do= Outstanding amount of the loan
r1=risk adjusted return for zero coupon loans for 1 year maturity
r2= risk adjusted return for zero coupon loans for 2 year maturity
rn=risk adjusted return for zero coupon loans for n year maturity

2. Constant Capital Repayment: In this type, repayments are done with

constant principal i.e. Total amount of the loan is divided equally for each
payment and with that interest is also paid on the outstanding amount.
Hence,
Do= (Do* rCCR,n +Do/n)/ (1+r1)1 +((Do-Do/n)* rCCR,n +Do/n) /(1+r2)2 + …
+((Do-(n-1)*Do/n)* rCCR,n +Do/n)/(1+rn)n
Where:
rCCR,n=risk adjusted return for constant capital repayment for n year maturity
loan
Do= Initial Loan amount
r1=risk adjusted return for zero coupon loans for 1 year maturity
r2= risk adjusted return for zero coupon loans for 2 year maturity
rn=risk adjusted return for zero coupon loans for n year maturity

3. Straight line Amortization: In this type of repayments, payments are same

at each payment date i.e. A part of the Equal payment is principal and
another is interest on the outstanding amount.
Hence,
Do=I/(1+r1)1 + I /(1+r2)2 +… + I/(1+rn)n
I= rSLA,n /(1-1/(1+rSLA,n)n)

Where:
rSLA,n= risk adjusted return for constant payments for n year maturity loan
I= Equal payments
Do= Initial Loan amount
r1=risk adjusted return for zero coupon loans for 1 year maturity
r2= risk adjusted return for zero coupon loans for 2 year maturity
rn=risk adjusted return for zero coupon loans for n year maturity

Pricing Methodology:
Inputs used:
• Rf
• PD
• RR
• SC
• SS
• RCC/RCS
• Base Rate
• n(years to maturity)
1. Inputs (PD, RR) are used to calculated regulatory capital requirement by Basel
II as:

Capital Requirement by Basel II:

 LGD= (1-RR)
R (correlation), b (Maturity adjustment)
M= Effective Maturity=2.5(as per Basel II-pg-74 para-318)
N is NORMSDIST function of excel which gives normal cumulative distribution.
G is NORMSINV function of excel which gives inverse normal cumulative distribution
of a value.

3. Inputs (rf, PD, RR, SC, SS, RCC/RCS) are used to calculate rni,adj using:

rni,adj for different years to maturity is calculated, using inputs of corresponding

years.(in above equation n is years)

For single Disbursement:

4. rBL, rSLA, rCCR are calculated for different years using formula:

For Bullet Loan

For Constant Capital Repayment

For Straight Line Amortization

 First I is calculated using risk adjusted return for different years to
maturity.

The corresponding risk adjusted rate for a type of payment is used to create the
repayment schedule for n year maturity loan.
For multi Disbursement:
4. The actual loan disbursed is calculated by applying forward rates on the
disbursed amount till the last disbursement. For eg, if A1 is the amount
disbursed after 1 year, A2 is the amount disbursed after 2 years and Am is
the last amount that is disbursed(i.e. at year m), then actual amount
disbursed is
A=A1(1+rm)m/(1+r1)1 + A2 (1+rm)m/(1+r2)2 +…. Am-1 (1+rm)m/(1+rm-1)m-1 +
Am

Where A1, A2… Am are entered by the bank manager.

5. Now for this Actual loan amount different repayments type are calculated
for different years using formulae and as defined( if payment is in nth year
and last disbursement was in mth year then for calculating rBL, rSLA,
rCCR year used is n-m for each payment).
6. The corresponding risk adjusted rate for a type of payment is used to
create the repayment schedule for n year maturity loan.

Note: If number of payments per year is not 1 i.e. for 2,4,12 payments
per year risk adjusted return calculated will be per payment, actual
stated r will be number of payments per year* rcalculated.
 Types of funded facility
1. Term Loan
2. Acquisition Financing
3. Short Term
4. Revolving credit
For Term Loan, Acquisition Financing and Short Term loans pricing both types of
disbursement and all types of repayments will be applicable, and corresponding
risk adjusted return will be calculated.

For Revolving credit as the actual exposure for the facility is not known and the
draw down can be many times with variable drawdown amount, for this facility
liquidity costs need to be incorporated in the risk adjusted return previously
calculated.

After calculating rni,adj for different years to maturity,

Exposure at default is calculated as:

EAD D UGD⋅UA

where:
D = Drawn Amount, which represents the portion of the total granted loan
actually used by the borrower;
UGD = Usage Given Default, which is a function of the borrower riskiness;
UA = Undrawn Amount, equal to the difference between the Granted (G) and the
Drawn amount (D).

As per Basel II foundation approach, UGD can be taken as 75%.

On the EAD, the bank applies the equivalent of the risk-adjusted rate rni,adj of
a fixed exposure loan and on the portion (1-EAD), the bank applies a surcharge
resulting from the difference between the future value the bank would earn if
invested such amount at the risk-adjusted rate – equal to (1−EAD) ⋅ (1+ rni,adj )n –
and the future value the bank would earn investing such amount at the risk-free
rate, this latter being equal to (1− EAD)⋅ (1+ rni,adj )n .
The difference between these two future values represents the Liquidity Cost
(LQC) on the loan with variable exposure
.LQC = (1− EAD)⋅ ( (1+ rn ) − (1+ rnf )n )that,
i,adj n

Hence risk adjusted return for the undrawn amount, will be

rn,ud i,adj = ((LQC/(1-EAD) +1)1/n-1)

It is easy to verify that when EAD = 1 (therefore, when the granted loan is fully
drawn) we fall back in the case of a loan with fixed exposure, where the Liquidity
Cost is obviously equal to zero.
Hence for Revolving Loans,
rni,adj will be risk adjusted return for the drawn amount and rn,ud i,adj is
the risk adjusted return for the undrawn amount.
 Types of unfunded facilities
1. Bank Guarantee
2. Letter Of Credit

Bank Guarantee:
For listed company:
1. V,va and L are calculated for a company from option pricing module.
2. D=L*exp(-r*T)
3. H1={Ln(D/V)- (T*va2)/2}/(T*va2)0.5
4. H2=H1+(T*va2)0.5
5. g(T)=N(H2)-N(H1)/(D/V)

N is NORMSDIST function of excel which gives normal cumulative

distribution.

g(T) is the cost of guarantee which need to be charged for a promised

payment.

Letter Of Credit:

The calculation of g(T) for Letter Of Credit is same as for Bank guarantees.

Listed vs non- listed companies

IF the firm is listed, PD is calculated from option pricing module for different
maturities.

If the firm is non-listed, PD is calculated from industry specific regression

module, which gives 1 year period PD. For cumulative PDs for different
maturities, 1 year PD is multiplied with the term to maturity.
After getting PDs the above mentioned risk adjusted facility methodology is
applied for different kinds of facilities.

Repayment Schedule
Given Parameters:

• Margin(%) = Margin in “repayment schedule” sheet is calculated as

corresponding R (risk adjusted) (either bullet, CCR, SLA)
• Margin = R-Base Rate
• Base Rate= Set by Bank
• Approved Amount=Initial Loan Amount
• Payments per year= Total number of payments per year for a loan.
• Tenor = Total number of payments in the given period.
• Disbursement Type=single, Multi disbursement.
• Payment (Type) = Three types of payment are till now incorporated i.e.
Equal Principal (CCR), Equal Payment (SLA), Bullet Payment (BL).
For Bullet Loan:

Principal: outstanding amount if last payment and 0 if not last payment.

Interest: (r(rate charged per year)/no. of payment per year)*Outstanding
Amount.
Balance: Outstanding amount if not last payment and 0 if last payment.
Payment: Interest+ Principal if last payment and Interest if not last payment.

For Straight line Amortization:

Principal: Payment- Interest
Interest: for 1st payment, Interest=(r(rate charged per year)/no. of payment
per year)*Initial Amount
For Other payment, Interest= (r(rate charged per year)/no. of payment per
year)*Outstanding Amount
Balance: For 1st payment, Balance= Outstanding amount- Payment + Interest
For other payments, Balance= Last Balance amount- Payment + Interest
Payment: As per Excel Formula
Payment= -PMT(rate, Tenor, Initial Amount)
Or
Initial Amount= (Payment/R)*[1-1/( 1+R)n)
Where:
R= r(rate charged per year)/no. of payment per year

For Constant capital Repayment:

Principal: Initial Amount/Tenor
Interest: (Initial Amount-((No.-1)*Principal)* r(rate charged per year)/no. of
payment per year
Balance: Initial Amount-No.*Principal
Payment: Principal + Interest