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Abstract

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. Copyright © 2009 John Wiley & Sons, Ltd.