What Exactly Is Funds Transfer Pricing (FTP)?
Funds transfer pricing (FTP) is a banking process employed to adjust the reported performance of various business units of a bank.
A financial institution, typically a bank, has two broadly classified business units — the deposit-raising units and funds-advancing units. The spread generated between these two units precisely determines whether the bank is positioned in a positive, or negative revenue adjustment.
Both borrowing and lending, the two underlying fundamentals of banking, are significant characteristics that affect the performance of a bank as a whole. FTP is essentially a mechanism to obtain the exact funding costs incurred by a bank in its various businesses.
The Prevalent Funds Transfer Pricing Best Approaches In Commercial Banks
There are diverse methods to assign FTP, however, the popular modules can be categorised into 4 broad segments
1. Single Pool Method. The method manages all banking products uniformly, assigning a single transfer rate irrespective of assets or liabilities. The method to some extent is at fault because it does not appropriately distinguish the product types and their characteristics.
2. Double Pool Method.. This module creates two pools: one of the assets and the other one of liabilities. The pools are assigned transfer rates on the basis of products parked in that pool. Average Loan Rate is applied for loans, and Mean Deposit Rate as FTP for the deposits. The module has a dominant presence but does not have the capacity to differentiate specific product attributes in the pool.
3.Multiple Pool Method.. Based on diverse criteria, such as product characteristic, maturity, and other related features, this method splits different products into multiple pools. Subsequently, the bank assigns assorted transfer rates to each pool, depending on the pool features and its properties. Multiple pool method takes into account the time structure of assets and liabilities, allowing for easy adjustments.
4.Matched Maturity Method.. FTP in Matched Maturity is assigned independently to the maturity of each transaction, and its anticipated cash flow. The transfer rate is designated on a particular ‘yield curve’, which outlines the bank’s ability to source fund maturities from the inter-bank market.
FTP Adds Value by Providing Deeper Insights into a Bank’s Performance and Its Financial Health
Often, there are situations, when at a particular point of time, loans appear more profitable than it actually is. FTP enables a full-proof policy for banks to acquire the exact Internal Rate of Return (IRR) on loans. It helps identify unprofitable advances, which usually lead a bank to acute liquidity issues and financial crisis.
Prudent FTP analyses can offer exceptional business insights that enhance banking performance, profitability, and decision-making. Some key benefits of FTP include:
Customer Evaluation: The spread, or the profit margin of a bank is accurately revealed when FTP rate is assigned to transaction levels based on the characteristics of a contract. The system helps analyse customer profitability by indicating which clients are adding, and which ones are eroding the bank’s net value.
Product Profitability: FTP interpretation can be attributed to a product, or a set of products, to determine outcomes that are more profitable for the bank. Allocating a unique FTP rate to a financial instrument can assist banks in assessing profitability at the product level.
Product Pricing: FTP framework leverages the benefits of surmising how well a particular product is priced in comparison to the cost of its funding and adjustments. The system renders an accurate guidance to price products correctly for optimised returns on investments.
Budgeting & Forecasting: A suitable FTP system integrates features that enable significant improvement in the annual budgeting process. It helps estimate accurate interest returns, which considerably aid in budgeting and forecasting realistic profitability targets.
An efficient FTP system can dramatically heighten the decision-making capabilities of a bank, leveraging increased profitability levels across diverse product lines and units.
Is your bank doing anything to get the most out of Funds Transfer Pricing (FTP)? Share with us in the comments below.
Author: Kishore Kapoor
Kishore Kapoor an industry veteran of 31 years in global banking technology. A Founder & CEO of eKutumb.com – World’s first marketplace for enterprise software delivery and consulting business by creating value for all of industry stakeholders involved (customers, partners, individuals and investors) through a disruptive and trans-formative approach of doing business.