What Is Funds Transfer Pricing (FTP)?

What Is Funds Transfer Pricing (FTP)?

Let me explain funds transfer pricing, or FTP, directly to you. It's a methodology I use to estimate how sources of funding contribute to a company's overall profitability. You'll see FTP most commonly in the banking industry, where it helps financial institutions analyze their strengths and failures.

I also rely on FTP to determine the profitability of various product lines, the performance of branch outlets, and the effectiveness of different business processes.

Key Takeaways

Understand that funds transfer pricing is a method to measure how funding contributes to overall profitability for a firm. FTP remains an important metric for internal analysis, with several regulatory guidelines provided for industry best practices. The single-rate and multi-rate methods offer two basic systems for internal FTP analysis.

How Funds Transfer Pricing (FTP) Works

Funds transfer pricing is an important reporting metric in banking management analysis and reporting. Financial institutions use it to measure overall profitability as well as the profitability of business segments, such as product offerings and customer relationships. You can apply it to determine if individual branches are economically viable.

The basis of FTP is that financial institutions should benefit from their core activities: lending and deposits. According to Moody's, a well-designed FTP system has a bank's Treasury department buy funds from the liability business unit and sell them to the asset business unit at a rate that balances both deposit and lending areas. This requires pooling information across assets and liabilities.

It's also analyzed alongside asset/liability management. You might evaluate FTP with other metrics like net income or net interest margin (NIM), which is the difference between a financial institution's income and interest expenses.

Importance of FTP Protocols

There's a great deal of risk for financial institutions that don't implement FTP protocols in their operations. Issues include mispricing of products and services leading to losses, business unit volatility from unhedged liquidity and other risks, and lack of clarity on real margins of products and services.

Important Note

Funds transfer pricing is different from transfer pricing, which is an accounting practice representing implied prices that one division in a company charges another for goods and services.

Funds Transfer Pricing (FTP) Methodologies

A variety of methodologies for FTP are used in the banking industry. Two basic ones are single-rate FTP, which provides a comprehensive view of assets versus liabilities by maturity—all assets and liabilities get a single transfer rate regardless of the product—and multi-rate FTP, which breaks assets and liabilities into groups based on selected characteristics, giving management a more granular view of risks.

The multi-rate methodology is often used for product and maturity breakouts, considering details like funding liquidity spread, contingent liquidity spread, credit spread, option spread, and basis spread.

Charting is a key part of all FTP methodologies. It represents pooled data across assets and liabilities, providing 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 have interfaces including all high-level FTP metrics they follow.

Fast Fact

Most global regulators have not incorporated FTP analysis into comprehensive bank regulatory reporting.

Example of Funds Transfer Pricing (FTP)

Many banks use FTP charting to analyze funding by location. Bank management uses FTP to determine the profitability of funds at individual divisions, accounting for deposits each branch brings in, the amount provided as loans, and the number of customers served.

If a particular branch is continuously underperforming baselines or reporting significant declines, it can lead to closure. When a branch closes, it typically transfers accounts and resources to another nearby location.

Since the 2007-2008 financial crisis, the U.S. government’s Dodd-Frank Act focused on increasing regulated liquid capital to reduce risk at largest banks. Funds transfer pricing analysis has gained increased attention from bank managers, but guidance has been informally introduced rather than mandated. According to Moody's, leading regulatory precedents for FTP best practices include the United States Federal Reserve’s SR16-3 letter.

Why Is Funds Transfer Pricing an Important Tool for Banks?

Funds transfer pricing is used by financial institutions to determine if their business is profitable. They also use this tool to evaluate profitability of different parts, including product offerings. Not having such a system can lead to mispricing of products and services, increasing volatility risk.

What Is the Difference Between Single-Rate and Multi-Rate FTP?

Single-rate and multi-rate funds transfer pricing are two methodologies used by financial institutions in banking. Single-rate FTP allows a comprehensive look at assets compared to liabilities, with all given a single transfer rate. Multi-rate FTP divides them into groups based on characteristics, providing a more detailed look at risks.

How Do Banks Earn Profits?

Banks earn profits from various sources. Main drivers are fees and service charges on customers, plus interest from loans and other credit products.

The Bottom Line

Companies use various tools to check if they're profitable. Funds transfer pricing is a system banks and financial institutions implement to assess overall success and that of individual units, products, and services. Not having FTP is risky, as it can lead to mispricing and increased volatility.