Fund transfer Pricing

liquidity to each business unit

FTP

Liability and asset units are

identified to obtain a leveled
balance sheet and net interest
spread per individual record is
created.
Any mismatched transaction is
posted into the intermediary,
The Treasury

Why FTP?

To ensure that the financial

statements of banks reflect
their true prevailing
economic situation

To measure profitability of
various branches, LoB

Without an FTP all deposits

would seem like they incur
only costs

The Global crisis in

2007 proved the
assumption false that
market based funding
would always be
available to finance
the illiquid assets

 Market based
financial risk
management
system
Profitability
independent of
interest rate risks
Centralized
measurement and
management of
interest rate risk

Benefits

Features

Objectives

Accurate Product
pricing-->price
based on market
benchmarks, risk
return based
product pricing
Profitability
management
centrally control
NIM, control cost
of funds,
Liquidity
management-->
net liquidity
across units,
centralized
deployment of
surplus

A useful tool to
assess the
performance of
individual bank
units
Provides a
benchmark for all
Transfer rates
against a market
derived yield rate
Central control of
NIM
Helps manage
structural liquidity
mismatches

Business units contributions

Three components:
Asset contribution

Liability contribution

Treasury contribution

Asset
Contr
ibutio
n

Liabili
ty
contri
butio
n

Treas
ury
Contr
ibutio
n

Calculation
Of
NII

Bank
Balance sheet

Commercial margin=
Customer price Internal price

Treasury
Balance sheet

Treasury margin =
Internal transfer price+
revenue and cost from
investing and borrowing
in the market

NII

NII loan = IR loan-TR

NII Deposit = TR- IR deposit
NII treasury = MR n year- MR m year

Transfer price

Internal price at which assets are bought or

sold within the company not the price at which
funds are bought from or sold to external
suppliers
The transfer price is arrived at using
benchmark rates or by using the average of
cost of funds and income from assets
Eliminates distortion of cost due to double
counting
Accurately determines value of bank's services,
products, make better decisions, determine
margins accurately

What must be transfer priced

All products
presented on
balance sheet

Investment
portfolio

Trading
activities

Non-earning
assets, equity,
non-costing
liabilities must
also be
transfer priced

Importance of setting an
accurate TP
Setting incorrect
TP may lead to
some units seen
as more profitable
at the expense of
other units.
Just like FTP
Artificial pricing
methods
that leads to
themselves, there
creation of
are different
artificially
methods to assign
profitable
TP
products

Single Pool Approach

Bank determines the average interest rates on bank's

products for both assets and liabilities.
Allocates all the assets into one single pool and the
liabilities in another pool
It does not consider factors like maturity and level of risk.
Interest received on loans and paid on deposits are
weighted by their outstanding balance
It results in a weighted average rate of interests of all bank
assets and liabilities.
Uniform transfer rate is applied to both assets and
liabilities
Best suited for small banks with stable but undiversified
source of assets

Advantages

Disadvantages

Requires little IT expertise

No separation of interest rate risk

from credit risk

Simple implementation

Does not take market rates into

account

Does not require costly data

system

Old, obsolete, inappropriate for

the risks existent today

Multiple Approach

Assets and liabilities are classified into different pools

using different criteria
Such criteria may include factors such as maturity,
the embedded optionality associated with the
instruments etc.
Each pool is assigned a different rate based on these
criteria
In multiple pool approach, the rates for different
pools can be calculated internally, but that results in
lack of objectivity.

Multiple Pool Approach Contd.

Best method is to base the transfer price on prevailing market

rates.
Transfer prices for every pool must be a reflection of the
prevailing market rates for various instruments.
Then the banks must come up with a transfer yield curve
which is a reflection of the market cost of funds.
Two transfer price curves, for assets and liabilities
Suitable for commercial banks that are active in interbank
market

Advantages

Does not require complex computing

Internally developed software can be used

Accurate calculation of profitability for pools of float rate products.

Commercial banks with many branches and interbank transactions

Disadvantages

Profitability of products subject to change in market rates

No separation of credit risk from interest rate risk

Matched maturity approach

Also referred to as co-terminus approach

Developed by BoA in 1970s
Prices are allocated to individual transactions instead
of amalgamating into pools
The most preferred FTP approach in financial industry
Complex but gives you the contribution margin of
every transaction
Also applies behavioral assumptions like prepayment
options, amortization and other embedded options.

Matched maturity approach Contd.

Each transaction is allocated a maturity specific transfer rate

Difference between asset yield and marginal cost o funds
comprise the profitability of purchasing an investment or
originating a loan
It uses historical market data to lock in interest spread, thus
interest rate risk is transferred to the fund center.
Also easier to assess effect of past pricing decisions
transfers risks to the intermediary and enables functioning of
business lines independent of market movements that are not
under their control.

Thank You