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Funds transfer pricing (FTP) is an internal measurement framework designed to assess the financial impact of a bank's sources and uses of funds. FTP allocates net interest margin variances caused by the imbalance of funds provided and used by business units within the bank. Results of the FTP measurements can be used to evaluate the profitability of products and customer relationships, and to isolate returns for various risks assumed in the financial intermediation process. While there are numerous transfer pricing frameworks and techniques, matched funds pricing methods are generally viewed as the most conceptually pure.
Matched FTP's purity stems from its assignment of a market-based "matched repricing term" transfer rate to each balance sheet transaction origination. Transfer pricing rates vary according to repricing term and other attributes, and should represent the alternative "opportunity" rate for the bank's sources or uses of funds. Many FTP practitioners recommend the use of a single curve, so asset and liability transactions of identical attributes are assigned identical transfer rates. When measuring performance, a transaction's transfer rate (or spread to a repricing index rate if the instrument's rate is adjustable) remains unchanged over its repricing life. Effectively, this insulates the transaction's margin contribution from the effects of subsequent market interest rate changes. Profit margins of transactions are known at origination.
Matched funds transfer pricing has been linked to A/L management as a way to centralize the bank's overall funding mismatch in a business unit specifically assigned the responsibility of monitoring and managing interest rate and liquidity risks. The bank's funding mismatch exposure is caused by the varying characteristics of the sources and uses of funds. While this is one of matched funds pricing's mantras, its usage to actually manage the funding position is somewhat dubious. This article discusses various ways matched funds transfer pricing can be used in AIL modeling and funding risk management.
First, it must be understood that matched fund transfer pricing does not mean transactions are actually match funded or paired off against one another. Banks generally do not have the capability or desire to eliminate all funding mismatches. Indeed, the boards of some banks believe mismatches should be encouraged to potentially improve profitability.
The assignment of market-derived transfer rates prescribed by repayment attributes allows lenders...