Welcome to My Presentation

Course B-505: Risk Management in Banking

Chapter 26: Fund Transfer Pricing

 Presented By :
Md. Nazmul Hasan
ID-12-032
12th Batch MBA
 FOREWORD:
Two main tools for integrating global risk management with Decision-making:

1. Funds Transfer Pricing (FTP) system 2. Capital allocation system

FTP serves to allocate interest income

Capital allocation system serves to allocate risks

 Three major FTP Issues: Goals of FTP

• The transfer of • Measuring the of

funds across performance
business units given the
and with the transfer price
ALM units
 FTP System Specifications:

 Transferring funds between units

 Setting target profitability for business units
 Transferring interest rate risk, which is beyond
the control of business units, to ALM
 Pricing funds to business units with economic
benchmarks, using economic transfer prices
 Eventually combining economic prices with
commercial incentives
 FTP Systems:
Specifications of the transfer pricing
system

Netting mechanisms for excesses and

deficits of funds

Measurement of performance

Simple calculations of interest income

Choice of target profitability and risk limits

for ALM and business lines
 Goals of the Transfer Pricing System

• Allocate funds within the banks

• Calculate the performance margins of a transaction
• Define economic benchmarks for pricing and
performance measurement
• Define pricing policies
• Transfer liquidity and interest rate risk to the ALM unit
FTP System and Its Applications
Internal Management of Funds & Netting:

• Internal Pools of Funds

• Netting:

Figure: Transfers of net balances only

Pricing of Outstanding Balances:

Figure: The central pool of all assets and liabilities

Measuring Performance:

Figure: The bank’s balance sheet and the ALM balance sheet
 FTP SYSTEM AND MARGIN CALCULATIONS:

• The Accounting Margin: Example

Given,
Transfer Price = 9.20%

• Direct calculation of the accounting margin

2000 × 12% − 1200 × 6% − 800 × 9% = 96
Breaking Down the Bank Margin into
Contributions of Business Units
Calculation of margins when ALM
Margin is Zero:
Analytical Income Statements:

Operating Cost
=64/3200
=.02 or 2%
Differentiation of Transfer Prices:
• Commercial Margin
= assets(12% − TP assets) + liabilities(TP liabilities − 6%)
• Commercial Margin
= assets × assets contribution (%) + resources ×
resources contribution (%)

 Reasons for Differentiation:

– Choose criteria for transfer prices.
– commercial signals for developing some markets and products while
restricting business on others.
 ALM Profitability and Risks:
• If its target profit is set to zero.

Cost • responsibility is to minimize the cost of

funding
• hedge the bank against interest rate risk.
Center: • This cost saving is its Profit and Loss (P&L).

• Has a target profit.

Profit • Optimize the funding policy within specified

limits on gaps, earnings volatility or VaR
• Liquidity and interest rate risks should

Center: actually be under ALM control.

• commercial margins should not have any
exposure to interest rate risk
Setting Target Commercial Margins:
M bank ( Accounting margin) = M commercial +M ALM

[(X − 8%) × 1000] − [960 x 10%] = 10

X = 10.6%
 Rationale of Transfer Prices:
 Financial standpoint:
• transfer prices should reflect market conditions

 Commercial standpoint:
• Customer prices should follow business policy
guidelines subject to constraints from competition.

Mispricing:
– Mispricing is the difference between ‘economic prices’ and effective
pricing. Mispricing is not an error since it is business-driven.
– Nevertheless, it deserves monitoring for profitability and business
management. Monitoring mispricing implies keeping track of target
prices and effective prices, to report any discrepancy between the
two.
Thank You Very Much for Your Patient
Hearing!!!