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FTP Webinar: Apr 2021 (Part 4)

May 4 @ 14:00 - 17:00 EDT

Funds Transfer Pricing:  The Key to Effective Risk and Profitability Management


In this 4-part webinar (3 hours each Tuesday), we review lessons learned from the last several business cycles, including what banks missed and why they missed it.  Drawing on these lessons, I describe how risk and profitability management are one in the same problem; they cannot be treated as separate and distinct, else the result will be conflicting stories of how the financial institution (FI) makes money.

Following a brief discussion on the sources of interest rate risk (IRR) and liquidity risk (LR), I show how a well-functioning funds transfer pricing (FTP) process immunizes lenders and deposit gatherers against these risks.  This is a key motivation for lenders and deposit gatherers to embrace FTP.  Without it, they are exposed to risks over which they have no control.

I provide a detailed description of the mismatch center and explain how it should contain all IRR- and LR-related earnings and earnings volatility.  In a well-functioning FTP framework, the earnings risk profile of the FI and the earnings risk profile of the mismatch center should be identical regardless of the risk profile of the FI.

I then walk through several balance sheet examples of IRR and LR to demonstrate why a financial institution’s funding curve must be constructed as the sum of a basis-adjusted swap curve plus the incremental cost of its senior unsecured debt (this is the FI’s credit spread relative to swaps).

The feedback from the FTP Conference participants was nothing short of excellent. Several product managers have reported that the workshop has positively influenced their decisions around which deposit products to promote and how they will price and manage them to maximize their value to their business units AND to the bank.  – Director, Funds Transfer Pricing, Royal Bank of Canada

Given that non-maturity deposits (NMDs) make up a material source of funding at most FIs, I describe a method of calculating the FTP rates on NMDs that follows logically from their IRR and LR cashflow attributes.  This approach compels deposit gatherers to consider how product behaviors (over which they have some control) drive the crediting rate they receive, i.e. the FTP rate is not arbitrarily imposed on them.  This understanding produces significantly more accurate measures of IRR and LR for the FI.