The winner either knows more about the customer's true value than his competitors or he has mispriced the deal. In the latter case, the winner is anything but happy after the error is made and the risk fully revealed. Observers of the modern financial world sometimes say commercial banking suffers all too often from this curse, underpricing and thereby landing some bad loans, while losing good loans because they were evaluated more rigorously and priced accordingly. To prevent this outcome, commercial banking must strengthen its own capabilities to analyze and price risk. When times get tough, competitors get tougher.
Bankers can no longer succeed in lending with imprecise tools and techniques.
Appropriate banking practice includes the evaluation of loans for risk. But this is not the simple process used by many of our predecessors. Today, loan analysis must include a specific quantitative loan rating. For most credit risk management procedures there are several grades of passing loans, as, of course, all loans do not have the same probability of loss or default risk. And, this variation in credit quality or default probability must be included in the pricing decision.