The Principles of Banking, 2nd Edition

CHAPTER 14Bank Funds Transfer Pricing¹

Abstract

Internal bank funds pricing is a key element in liquidity risk management. An inappropriate or artificial internal funds pricing policy can drive poor business decision making as well as generate excessive liquidity and funding risk exposure. So it is important to operate a robust and disciplined internal funding mechanism, and one that is integrated into the overall liquidity risk management framework. We review the rationale behind the concept of the bank's internal term liquidity premium and present a recommended good-practice policy template for internal funds pricing.

The internal funds pricing mechanism – often referred to as funds transfer pricing (FTP), or occasionally firm liquidity pricing (FLP), liquidity transfer pricing (LTP) or term liquidity premium (TLP), although these terms are not synonymous – is usually operated via the Treasury function.

FTP is important in the risk management process essentially because, as it is the price at which an individual business line raises funds from its own Treasury desk, it is a key parameter in business decision-making, driving sales, asset allocation and customer product pricing. It is often used as a hurdle rate behind the product approval process and in an individual business line's performance measurement. Analogous with capital allocation decisions affecting front office business units and their need to account for the cost of capital (in terms of return on regulatory capital), ...