Funds transfer pricing

Funds transfer pricing (FTP) is a process used in

banking to adjust the reported performance of dierent business units of a bank. A bank could have dierent kinds of business units. The split of these units between deposit-raising units and funds-advancing units affects whether they receive a positive or negative revenue
adjustment. Both borrowing and lending contribute to the
performance of the bank as a whole. FTP is a mechanism
to adjust these protabilities to incorporate true funding
costs.

ity reporting. Failure and bail-outs of banks has made

reported liquidity a hot topic. FTP calculation is complicated by a number of factors which make calculation
of the revenue adjustment needed dicult. Factors affecting funding cost include the length of time an asset or
liability is repaid (Liquidity Term Premium), the extent
to which an asset has been or can be securitised (which
aects its liquidity) and the *behaviour* of customers in
particular product/customer niches, customers propensity
to withdraw long term asset deposits at penalty or to repay
obligations such as mortgages early all aect real funding
cost. This behaviour factor complicates the calculation of
FTP and has required signicant and expensive changes
to banking systems. Balance sheets now incorporate new
attributes for customer and product which were not previously signicant reporting dimensions.

An intermediary is created within the organisation usually treasury or central oce. All the fund-raising units
raise funds from the market at a particular rate and lend
the same to the central oce at a higher rate. All the
lending units borrow the funds from the central oce at
a particular rate and lend the same to the borrowers at a
higher rate. The central oce rate is notional in nature
and is aligned to market conditions. Thus for all the units
there are two rates available to measure the performance.
For a deposit-raising unit the dierence between interest
paid to the deposit-holders and interest receivable from
central oce is the contribution to the banks protability. For a lending division the dierence between Interest
payable to central oce and the interest received from the
borrowers is the contribution to the banks performance.

One important issue to be considered in calculating FTP

is the need to value funding costs on an at arms length
basis.
To understand at arms length one has to understand how
relationships aect behaviour. Some conventional transfer pricing issues can be considered to explore this.

A good example is a father selling a home to his son.

The value of such a transfer may not be considered to
be the same as what would be achieved on the open marFTP is therefore a revenue adjustment made to the banks ket.Similarly businesses often manipulate sales of asset
Balance Sheet to reect funding cost impact.
through inter-company trades to maximise protability
For example, a business unit which manages funds for in low tax environments.
high-net-worth individuals will create cash which is held In banking terms the fact that a loan is made between
on deposit. That deposit will accrue interest therefore the business units may reect agreed or contracted recogniWealth business units prots will have to be increased tion of (too low in the nancial crisis) costs rather than
by the deposit interest which can easily be calculated by prevailing actual accurate funding costs and this is both an
using the prevailing rate of interest.
important audit concern and of taxation interest as transfer pricing aects where and in which business unit prot
is reported.

This approach became problematic during the 2007/8 nancial crisis because actual interest rates paid began to
dier from published rates such as Libor or bank base
rates very substantially. With poor credit availability the
prot adjustment made in favour of depositing business
units was eectively understated. This had been less an
issue when banks borrowing costs were close to base
rates or quoted rates such as LIBOR.

As a result of the attention on funds transfer pricing that

resulted from the 2007/2008 nancial crises, the U.S.
Federal Reserve, Federal Deposit Insurance Corporation,
and the Oce of the Comptroller of the Currency issued
regulatory guidance for large banks formalizing an approach to funds transfer pricing for the rst time. The
Failure to calculate FTP correctly can cause loans to be guidance required a number of formalized processes inmuch less protable than they initially appear and the fact cluding requiring large banks to prepare funds transfer
that banks have extended unprotable loans is a key factor pricing reports and a standardized funds transfer pricing
process be implemented across the institution.[1]
in the recent nancial crisis.
FTP has become important because banks are expected
to state their funding costs accurately as a regulatory requirement, because funding costs aect a banks liquid1

References

[1] Five key points from the interagency funds transfer pricing guidance (PDF). PwC Financial Services Risk and
Regulatory Practice, March, 2016.

External links
What is Funds Transfer Pricing? J. Coey, CPA and
Gene Palm

EXTERNAL LINKS

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