What Is Funds Transfer Pricing (FTP)?
Funds transfer pricing (FTP) is a managerial accounting framework banks use to allocate the cost and benefit of funds between the parts of the bank that raise funds (liabilities, e.g., deposit-taking and wholesale borrowing) and the parts that use funds (assets, e.g., lending and investment portfolios). FTP produces internal transfer rates so that business lines, product managers and branch managers can be measured on the economic contribution of their activities, not just their nominal interest flows.
Key takeaways
– FTP converts funding costs and funding benefits into internal transfer prices so business units are measured on economic profitability.
– It sits at the intersection of Treasury, asset/liability management (ALM), product management and performance reporting.
– Common approaches are single-rate FTP (one internal rate) and multi-rate FTP (rates by product, maturity, or risk characteristics).
– Good FTP requires governance, high quality data, clear assumptions for liquidity and credit spreads, and regular review/stress testing.
Sources: Investopedia, Moody’s Analytics, KPMG, Federal Reserve SR 16-3.
Why FTP matters (and what can go wrong without it)
– Provides economic performance measurement: helps determine which products, branches and customer segments create or consume economic value.
– Prevents mispricing: without FTP a deposit-rich branch could look profitable even if it’s subsidizing loan growth elsewhere.
– Links pricing, liquidity and credit: FTP can incorporate term structure, liquidity spreads and optionality so pricing decisions reflect true costs.
– Regulatory and risk management alignment: FTP supports ALM, liquidity risk management and stress-testing frameworks.
Risks of poor or absent FTP: mispriced products, distorted incentives, over- or under-investment in businesses, unexpected profitability swings and inadequate liquidity-cost signals (increasing operational and franchise risk).
How FTP works — the mechanics
1. Central idea: Treasury (or the centralized funding desk) “buys” funds from liability units at a transfer (internal) rate, and “sells” funds to asset units at a transfer rate. The spread between the asset-side transfer price and the liability-side transfer price is a contribution to net interest margin (NIM) and profitability.
2. Pooling and charting: FTP pools balance-sheet items across maturities and creates a curve or matrix that links yield-to-maturity (YTM) to time-to-maturity. Charting provides the visual and data basis for allocating rates.
3. Add-on spreads: In granular FTP (multi-rate), the base funding curve is adjusted for liquidity spreads, contingent liquidity, credit spread, option spread (for prepayments or deposit options), and basis spreads.
4. Allocation methods: Funds can be matched by maturity (term-matching), by behavioral maturity (for deposits with no contractual maturity), or by using a running pool approach (e.g., matched, residual, or notional pools).
FTP methodologies
– Single-rate FTP (simple): One internal transfer rate is applied to all assets and liabilities. This gives a simple, aggregate picture of asset vs. liability economics. Pros: simple, lower data needs, easy to explain. Cons: masks product-level or maturity-specific economics and incentives.
– Multi-rate FTP (granular): Transfer rates vary by product type, maturity bucket, or risk characteristic. Typical components:
– Base wholesale funding curve (term structure)
– Funding liquidity spread (cost of unencumbered liquidity)
– Contingent liquidity spread (cost of stress-time liquidity)
– Credit spread (reflects credit risk of borrower or product)
– Option spread (for prepayments, checkable deposits, or callable assets)
– Basis spread (currency or market basis differences)
Multi-rate FTP is used for product-level profitability, pricing, and capital allocation decisions.
Charting and systems
– Charting (FTP curve or matrix) shows the pooled association between yield-to-maturity and time-to-maturity. It’s the central output used by product managers, ALM and Treasury.
– An internal interface/dashboard typically shows funding curves, deposit behaviors, FTP allocations by business line and trend analysis. Good FTP requires reliable front-to-back data: balance sheet, product features, customer behavior, pricing history, and wholesale funding inputs.
Example (illustrative)
– Simplified single-rate example: Treasury sets a single internal funding rate of 2.0%. A loan that charges a customer 5.0% yields a 3.0% FTP contribution (5.0% – 2.0%). A deposit paying 0.5% would be charged to the branch as a “cost” of –0.5% relative to the internal rate (or alternatively the branch is credited with the difference between internal rate and paid rate, depending on conventions).
– Multi-rate example: Treasury’s base curve for 3-year funds = 2.2%; add a product-specific option-cost of 0.3% for a mortgage with prepayment risk and a liquidity premium of 0.1% gives a transfer rate of 2.6% for that mortgage. If the mortgage yield is 4.8%, the FTP contribution is 2.2% (4.8% – 2.6%).
FTP and regulation
– FTP is not uniformly mandated in regulatory reporting, but regulators expect robust liquidity and funding governance. In the U.S., supervisory guidance (e.g., Fed’s SR 16-3) highlights the importance of FTP in managing funding and contingent liquidity risks. Since the 2007–2008 crisis and Dodd-Frank, banks and regulators have paid more attention to FTP as part of ALM and liquidity regimes.
Practical steps to implement or improve an FTP framework
1. Establish governance and objectives
– Define the objectives (pricing, performance measurement, liquidity risk signalling, capital allocation).
– Assign governance: board oversight, ALCO/Treasury ownership, roles for finance, risk, business units.
– Document policies and review cadence.
2. Inventory and classify balance-sheet items
– Identify all funding sources (retail deposits, wholesale funding, capital) and asset/funding uses.
– Classify by contractual term, behavioral maturity, currency, optionality, and callable features.
3. Choose a methodology aligned to objectives
– Simple institutions or consolidated reporting: single-rate may suffice.
– Product pricing, branch profitability, and behavioral deposits: choose multi-rate, with explicit models for liquidity, option and credit spreads.
4. Build the funding curve and add-on spreads
– Construct base term structure from market wholesale funding and internal marginal funding costs.
– Specify and justify liquidity and contingent liquidity spreads and option-cost models (e.g., prepayment models for mortgages, behavioral decay for deposits).
5. Data, systems and charting
– Ensure consistent, high-quality data: granular product balances, pricing, maturities, prepayment behavior.
– Implement an FTP engine or module in ALM/Treasury systems capable of producing curves, doing matching, and generating dashboards.
– Produce FTP charts and product profitability reports accessible to business lines.
6. Allocate funds and compute internal P&L
– Apply transfer rates to asset and liability balances to compute internal NII (net interest income) contributions by product/branch.
– Define how residuals (e.g., mismatch positions) are treated (designated to Treasury, redistributed, or held centrally).
7. Integrate with pricing and incentives
– Feed FTP outputs into product pricing tools and business line KPIs.
– Ensure incentives align: managers should be evaluated on economic P&L, not just nominal volumes.
8. Stress testing and scenario analysis
– Test FTP under liquidity stress, market-wide funding spikes, deposit outflow scenarios, and rate shocks.
– Include contingency funding plans and contingent liquidity spreads in stress scenarios.
9. Controls, validation and documentation
– Validate models and assumptions regularly (model risk management).
– Maintain versioning and change control for FTP curves and parameters.
– Document methodologies, data sources and governance minutes for audit and regulatory review.
10. Continuous improvement and review
– Revisit spreads, deposit behavior, and option costs based on actual experience.
– Align with evolving regulatory guidance (e.g., SR 16-3) and industry practice (Moody’s/KPMG whitepapers).
Common pitfalls and best practices
– Pitfalls: using stale or aggregated data, ignoring behavioral (non-contractual) deposit characteristics, underestimating contingent liquidity costs, and poor governance.
– Best practices: use granular behavioral models for deposits, explicitly model optionality, maintain a clear separation between Treasury pricing and business profit measurement, and update FTP assumptions frequently (market shocks may change marginal funding costs quickly).
Single-rate vs. multi-rate — which to use?
– Single-rate is appropriate for high-level reporting or smaller institutions with limited data and simpler balance sheets. It provides simplicity but can obscure product-level economics.
– Multi-rate is preferred when the bank needs product-level profitability, pricing precision, and to reflect different maturities, liquidity and optionality. It requires better data and governance but provides more accurate signals for business decisions.
How banks earn profits (a quick reminder)
– Interest income: net interest income from loans and securities (loan yield minus funding cost). FTP quantifies the internal funding cost assigned to assets.
– Fee and non-interest income: account fees, payment fees, advisory, trading and merchant services. FTP primarily addresses interest/economic allocation; fees are allocated through complementary transfer pricing for non-interest income.
– Cost management and capital allocation: FTP helps decide where to allocate capital and product pricing to maximize economic return.
Governance checklist (quick)
– Board approval of FTP policy and objectives
– Clear owner (Treasury/ALM) and stakeholders (finance, risk, business units)
– Regular reporting to ALCO and executive committee
– Model validation and auditability
– Documentation for changes and scenario results
The bottom line
FTP is a critical management tool for banks to convert funding economics into internal prices, providing more accurate profitability measurement, better pricing signals and improved liquidity risk management. Implementing FTP requires clear governance, quality data, choice of appropriate methodology (single vs multi-rate), explicit modeling of liquidity and optionality, and continuous validation and stress-testing. When done well, FTP aligns business incentives with economic reality and supports stronger funding and ALM decisions; when done poorly or not at all, it can lead to mispricing, distorted incentives and elevated risk.
Sources and further reading
– Investopedia, “Funds Transfer Pricing (FTP)” — https://www.investopedia.com/terms/f/ftp.asp
– Moody’s Analytics, “Do Funds Transfer Pricing Methodologies Still Work with Excess Deposits?” and “Funds-transfer-pricing in Banks: what are the main drivers?”
– KPMG, “Fund Transfer Pricing” (practitioner guidance)
– Board of Governors of the Federal Reserve System, SR 16-3: Interagency Guidance on Funds Transfer Pricing Related to Funding and Contingent Liquidity Risks
If you’d like, I can:
– Draft a one-page FTP policy template for your bank, or
– Create a small numeric FTP spreadsheet example (single-rate and multi-rate) you can plug your own numbers into. Which would you prefer?