Risk‐adjusted pricing strategies for the corporate loans business: do they really create value?

The corporate loans business of banks is often unprofitable. As it does not earn the cost of capital plus an additional profit margin, it is stigmatized as a value‐destroyer. Two rather obvious reasons are low margins in combination with high competition. Bank managers have mainly reacted to this negative trend by implementing cost‐cutting programmes and downsizing. While these actions helped to improve return on equity in the short run, the downside of these programmes has been a decline of earnings in the long run. Using the case of four major banks in Germany, our analysis shows a cyclical as well as a structural problem preventing these banks from creating value. Risk‐adjusted pricing is one strategy intensely discussed in theory and practice to improve earnings. We test this strategy against a variety of scenarios using a formal model and find that risk‐adjusted prices can indeed contribute to improved performance.