Reasoning by Analogy
In Banking, there are no barriers to imitation. The moment one Bank launches a new product, others are quick to replicate it. Any lender—Bank, NBFC, or Fintech—can easily build a product suite simply by following the leader.
This quick-fix is what we call ‘reasoning by analogy’— deciding based on what has worked in the past, for oneself or others. It works until the inevitable product and portfolio challenges arise.
However, for long-term sustainability, you need to innovate, differentiate, and pioneer new approaches while managing risk well. First Principles Thinking is exactly what works here.
The First Principles Thinking
First Principles Thinking is a problem-solving approach that involves breaking down complex issues into their most basic, fundamental elements and questioning the very assumptions on which conventional solutions rest. Let me explain by contrasting it with the typical Bank approach to product development.
Early in my career, I recall my then Bank launched an Unsecured Business Loan based on a simplified ABB (average Bank balance) assessment. The product essentially targeted non-credit ETBs with high balances in current accounts. Most customers weren’t interested, except those who needed the facility, somewhat desperately, to manage unpredictable short-term cash-flow mismatches. Long story short, it turned out to be a small-ticket, high-delinquency product and was eventually shut down.
Today, many digital surrogate data points can simplify and strengthen assessment, but this wasn’t the case a decade or two ago. We can debate whether it was ahead of its time, or just poor design; in either case, someone should have gone to first principles and asked—Who are we targeting? And why? Who will still need such credit? Is this simplified assessment robust enough?
With this in context, let me share an 8-point blueprint that can help lenders build robust products based on their own strengths and constraints.
1. Who Is It For? (Customer Segmentation)
Customer segmentation can often be tricky. Banks tend to use broad generalizations for scale, while many lending Fintechs opt for narrow segmentation to differentiate. For example, an ‘Unsecured SME Loan’ isn’t wrong except that SME is generic and not a homogeneous segment. Sub-segmentation- Trader Loan, Merchant Loan, Loan for Professionals or Doctor Loan, brings better clarity, whether as separate products or as policy variants. But there again, you can’t overdo it with, say, a Neurosurgeon Loan!
What really works is an optimal target market based on data and not heuristic. Just like a start-up pitch, you need a factual estimation of Product’s TAM (Total Addressable Market), viable SAM (Serviceable Available Market) clusters, and realistic SOM (Serviceable Obtainable Market),
Product and target market misalignment has a domino effect on both business and risk objectives, leading to poor adoption, low growth, or high default rates. Segmentation is so crucial that even Banks with no differentiation and outdated processes can survive for long simply because if they find their optimal segment.
First principles approach can help balance specificity with market size—What is the target market? Is it large enough to be viable? What parts are realistically addressable and obtainable?
2. What Are We Ready to Lose? (Risk Management)
Risk estimation involves analyses of identifiable risk variables as well as uncertainties. However, product-level risk is mostly relegated to good-to-have checklists.
For example, a key quantifier of risk is provisioning. It works at two levels. First, general and specific provisions based on regulatory norms. Secondly, discretionary provisions based on Banks’ own perceived or actual risk enhancement and profit elbow room. In either case, it is primarily a balance sheet-level generalization.
First principles involve quantifying risk at the product level during design, not post-facto. You anticipate and articulate product-specific risk variables and mitigations within the product note.
3. How Will It Be Delivered? (Distribution Strategy)
To reach different customer segments, Banks maintain multiple channels—branches, DSAs, co-lending arrangements, and even doorstep services. Each of these has its own efficiency, efficacy, and costs. Each brings its own credit, operational, and market risks as well.
Distribution isn’t just about having a channel; it’s about understanding how your target customer prefers to interact with you and deciding what brings efficiency to your delivery. A common error, for example, is to assume digital channel is smart or omnichannel is a panacea.
First principles: Is our distribution aligned with customer preferences? Is it efficient and effective? What’s the ‘channel risk’ in our product?
4. Are We Equipped to Handle It? (Process Capabilities)
In my experience, both over- and under-estimations are common in 3 areas.
Firstly, skill-sets overestimation. As loan sizes increase, so do the demands for judgmental skills and operational complexity. Business teams, especially in commercial lending, need a strong Banking bias, not just sales skills. Banks overestimate both, ability to upskill and ability to recruit, if needed.
Second, the system stack—CRM, LOS, LMS, and DMS. Banks often underestimate the time needed for customization and overestimate their systems’ ability to handle new workflows at scale, leading to fire-fighting with inefficient stop-gap manual interventions.
Lastly, consider man-machine interaction. They overestimate intuitiveness of a new system and assume that a short training will suffice.
Returning to first principles, you map out the process threadbare: What are the actual constraints and failure points? What will be the contingency flow? What are the non-negotiable product priorities the process must deliver—e.g., decisioning TAT and operational TAT or FTR? And, are the teams prepared-culture and skill? How will they adapt to changes in origination, operations systems, or documentation?
I recall Goldratt’s book ‘The Goal’ and his Theory of Constraints as helpful reading here.
5. Is the Product Competitively Priced? (Pricing Strategy)
Pricing is a function of risk, efficiency, and your target customer segment. Higher risk means higher Cost of Capital, inefficient processes mean higher Cost of Acquisition, and wrong Customer Segmentation will lead you to compete where you should not. There are potential gaps in the current pricing models.
Firstly, RAROC (Risk-Adjusted Return on Capital) tends to become a spreadsheet-tweaking exercise based on generalised regulatory benchmarks.
Banks price for customer-level risk (PD -Probability of Default), but there’s no methodical assessment of the customer’s context—vicinity, reference, urgency, price sensitivity, and brand perception. Ignoring this leads to under or over-priced products. Which in turn means frequent pricing deviations that dilutes targeted IRR benchmarks
Secondly, the absence of product-level cost allocation may lead to ambiguity in NIM (Net Interest Margin) and ROA (Return on Assets) expectations. Most Banks approximate business level cost allocation.
To be realistic, it’s easier said than done- some risk and costs are necessarily managed at organization level. However, a product-level pricing, even when partially successful, will bring clarity to GTM (go-to-market) strategy. You can’t go to your target market with a high-level, mathematically derived price and then push the sales team to perform miracles.
First principles: How do we ensure that the pricing reflects risks, costs, and competitiveness appropriately at the product level? Can some cost inflators be managed without organization-level changes? What is the customer context and price elasticity?
6. Are We Leveraging Digital Tools? (Technology Integration)
Technology can break barriers across all stages, from origination to post-loan service. However, it demands continuous investment. Your product design should anticipate scalability, stability, cybersecurity, privacy, and regulatory requirements, embedded into the tech architecture. Further, UI/UX focus is an essential differentiator amid the digital clutter that customers face, and data integrity at the source is crucial to effectively using intelligence/AI tools.
First principles mean aligning technology with core product goals—enhancing customer experience, protecting users and compliance by design. We essentially break down the desired process to identify what tech needs to deliver, not only today, but over the product lifecycle.
7. Are We Following the Rules? (Regulatory Compliance)
Unbridled creativity in Banking can be risky, as regulations can quickly constrain or kill products. The recent impact on Cryptos, BNPL, and Co-lending models illustrates this. Regulators prioritise systemic stability over innovation. Therefore, compliance cannot be an afterthought. It’s a first principle.
Is the product in line with the spirit of regulations? How can we balance product innovation with compliance? Is the process taking care of red lines?
If your idea pushes traditional boundaries, consider sandboxing it first.
8. What About Sustainability and Social Impact? (ESG)
Think ESG first, not only for ethical reasons but also for strategic benefits.
While Green Financing and Financial Inclusion loans are no-brainers, it is necessary to assess the ESG impact of all products. The analysis of impact, big or small- from reduced paper use and energy savings to shorter TAT and lower friction for non-tech-savvy or differently-abled users- all enhance product’s appeal. Governance is to be embedded within the design with transparent reporting, fair allocation of powers, and ensuring the system works without bias or prejudice.
First principles prod you to ask how the product aligns with broader ESG goals beyond profitability. Can you enhance and estimate it?
It does require some effort to articulate it.
First Things First
This blueprint is not exhaustive but should serve as a strong foundation for any Banker embarking on the journey to design lending products that are not only competitive but also sustainable and aligned with long-term business objectives. But first things first. Reasoning by analogy is about iterating on existing ideas. It’s quick but only takes you so far. First principles thinking is what drives true innovation and long-term differentiation. It’s about prioritizing fundamentals over force-fitting fancy features.