Asset-Liability and Liquidity Management

CHAPTER 12Funds Transfer Pricing

Funds transfer pricing (FTP) is an internal process to assign funding rates to interest-earning assets and earning rates to fund-generating liabilities of a bank. The FTP process is a useful tool in measuring the ex-ante risk-adjusted performance of the business units of a bank, especially for banking books consisting of products such as commercial loans, home mortgages, and deposits. Three main purposes of funds transfer pricing are:

1. Internal allocation of the net interest margin among different business units
2. Centralization of interest rate and liquidity risk management
3. Internal allocation of the cost of managing interest rate and liquidity risks to each business unit based on riskiness of positions

Traditionally, the treasury department of a bank manages the liability side of the balance sheet and along with the deposit units incurs the liability cost for the entire bank. This cost is mainly in the form of interest expense. On the other hand, business units manage the asset side of the balance sheet, including loan and lease portfolios that generate income, mainly in the form of interest income and fees. An FTP system treats each part of the bank as a value-adding entity. This is done by assigning earnings to the treasury and deposit units for their fund-generating activities and costs to business units for their use of funds and risk-taking activities. This turns each entity into a standalone profit center that contributes to the bank's ...