Funds Transfer Pricing (FTP): What It Is and How It's Calculated

What Is Funds Transfer Pricing (FTP)?

The term funds transfer pricing (FTP) refers to a system that is used to estimate how funding adds to a company's overall profitability. FTP is commonly used in the banking industry to help financial institutions analyze their strengths and failures. FTP may also help companies determine the profitability of various product lines offered, the performance of branch outlets, and judge the effectiveness of processes.

How Funds Transfer Pricing (FTP) Works

Funds transfer pricing is an important reporting metric that is used in banking management analysis and reporting. Financial institutions use this tool as a way to measure their overall profitability as well as the profitability of different segments of their business, such as product offerings and customer relationships. They can also determine whether keeping certain branches open is economically viable.

The basis of FTP is that financial institutions should benefit from both of their most basic activities: lending and deposits. According to Moody's, an FTP system that is well-designed will have a bank's Treasury department "buy funds from the liability business unit and then sell those funds to the asset business unit at a rate that balances both the deposit and lending activity areas." As such, FTP requires the pooling of information across assets and liabilities.

It is also analyzed in conjunction with asset/liability management. FTP may also be evaluated alongside other metrics, such as net income or net interest margin (NIM), which is the difference between a financial institution's income and interest expenses.

There is a great deal of risk involved if financial institutions that don't implement FTP protocols within their operations. Some of these issues include (note that this isn't an exhaustive list):

• Mispricing of products and services, resulting in losses
• Business unit volatility as a result of liquidity and other risks that aren't hedged or transferred
• Lack of clarity on the real margins of products and services
  

Funds Transfer Pricing (FTP) Methodologies

There are a variety of methodologies for FTP used in the banking industry. Two of the most basic methods include:

• Single-rate FTP, which provides a comprehensive view of assets versus liabilities by maturity. With the single-rate method, all assets and liabilities are assigned a single transfer rate regardless of the nature of the product.
• Multi-rate FTP, which breaks assets and liabilities into additional groups based on selected characteristics. With the multi-rate method, management has a more granular view of risks.

The multi-rate methodology is often for product and maturity breakouts. In these breakouts, some of the more granular details of consideration may also include the funding liquidity spread, the contingent liquidity spread, the credit spread, the option spread, and the basis spread.

Charting is a key part of all FTP methodologies. Charting represents the pooled data across assets and liabilities. In general, it provides a visual picture of the association between yield-to-maturity (YTM) and time-to-maturity. Charting can be customized based on methodology and report requirements. Internally, financial institutions will have an interface that includes all of the high-level FTP metrics they are following.

Example of Funds Transfer Pricing (FTP)

Many banks use FTP charting to analyze funding by location. Bank management would use FTP to determine the profitability of funds at individual divisions. This analysis takes into account the deposits each branch brings in, the amount provided as loans, as well as the number of customers the location serves. If a particular arm is continuously underperforming established baselines or reporting significant declines, then it can lead to a branch closure decision. If a branch closes, it will typically transfer accounts and resources to another nearby location.

Since the 2007-2008 financial crisis, the U.S. government’s Dodd-Frank Act primarily focused on increasing the regulated level of liquid capital to help reduce risk across the largest banks. Funds transfer pricing analysis has gained increased attention from bank managers as well, but guidance has been more informally introduced rather than mandated.

According to Moody's, some of the leading regulatory precedents for funds transfer pricing best practices include those created by the United States Federal Reserve’s SR16-3 letter.

The Bottom Line

Profitability is a key metric for any business. There are different tools that companies can use to determine whether they are in the black. Funds transfer pricing is a system that banks and other financial institutions can implement to assess their overall success and that of their individual business units, products, and services among other things. Not having a system like this can be risky for financial institutions because it can lead to mispricing and increased volatility.