What is Funds Transfer Pricing?

• Author: Coffey, John J.
• Position: Brief Article

Using FTP for your bank's pricing could also transform your marketing department from a cost center into a profit center.

John J. Coffey, CPA, and Gene Palm are the principals of Profit Resources, a consulting company that specializes in MCIF technologies;

What is Funds Transfer Pricing?

When pricing bank products, if you charge too little for your loans or pay too much for your deposits, you end up with less net interest income--that is, less profit.

A bank's total net-interest income is the difference between its interest income (generated from loans) and interest expense (paid on deposits). What's essential to know is that the net interest income is by far the largest driver of product profitability, typically accounting for up to 80 percent of a bank's revenue.

Your income statement is designed to calculate net-interest income for your entire bank. It is not designed to calculate the net-interest income of your products. In order to calculate net interest income for your products, your bank needs to take value away from its loans by using a "funding rate"-and add value to its deposits by using an "earnings rate." This process is called funds transfer pricing (FTP).

Methods for calculating FTP

Single-Pool FTP: By using single-pool FTP, the funding rate is the same rate as the earnings rate. This rate could be your investment portfolio yield. However, single-pool FTP doesn't take into consideration the maturity of your products. For instance, the FTP on a 30-year mortgage would be the same as the FTP on a three-month CD even though a 30-year mortgage may be more risky to your bank (from an asset/liability management perspective).

Multiple-Pool FTP: By using multiple-pool FTP, each portfolio of products is given an FTP rate based on its maturity. The funding rates for loans and earnings rates for deposits are based on a yield curve.

Short-term loans (e.g., credit cards or lines of credit) usually have higher interest rates than long-term loans (e.g., mortgage loans), resulting in higher net-interest income. Unlike a mortgage loan that is secured by your house, these short-term loans are not typically secured with collateral and therefore are more risky loans for the bank to make. Because they have more risk, the bank typically charges more interest for these short-term loans.

On the other hand...