BFSI Chronicle, 20th Edition March 2025
Funds Transfer Pricing Mechanism
In The Banks
F unds transfer pricing is an internal allocation and
measurement mechanism for determining the pricing of
incremental loans/investments/deposits and for determining
the profit contribution of various lending and borrowing
units of a bank. It is critical component of the profitability
measurement process, as it allocates the major component of
profitability in a bank, net interest margin. It’s a management
decision tool and is useful means to identify the areas of
strength and weaknesses within the bank.
Funds Transfer Pricing Mechanism
Under FTP, the central funding unit determines the transfer
price curve for various maturities from time to time based on
the policy approved by the asset liability committee.
The bid curve (i.e. the transfer pricing curve used for liabilities
of the bank) is to be based on the marginal cost of borrowing
and servicing cost for different maturities. While arriving
at this, liabilities such as current account/savings account
with non-determinate maturity may be categorised based
on statistical behavior model.
Offer curve (i.e. the transfer pricing curve used for assets of
the bank) is calculated as bid rate adjusted for the following:
1) Cash reserve ratio (CRR) and statutory liquidity ratio
(SLR) negative carry liabilities: Benefit of CRR is to be
given for inter-bank liabilities.
2) Liquidity charge for maintenance of liquid assets:The
extent of liquidity cushion to be maintained by the
bank may be determined through the use of statistical
behavioral model, stress-testing and scenario analysis.
The cost of maintaining such liquidity buffer would be
added to arrive at the offer rate. Also, business activities
Shri Govind Gurnani creating the need for the bank to carry additional liquidity
Former Assistant General Manager such as undrawn facility may be charged based on their
Reserve Bank of India expected usage of contingent liquidity.
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BFSI Chronicle, 20th Edition March 2025
3) Term premia depending upon slope of deposit
rate curve and other market rates.
Every liability raised by the business unit is to be
“transfer priced” using the prevailing bid rate for
the matching maturity. Similarly, every asset at the
time of origination is to be “transfer priced” using
the prevailing offer rate for the relevant maturity.
For amortising assets, each cashflow is to be treated
as an individual bullet loan for that maturity and
priced accordingly to arrive at a composite rate for
that asset. The difference between the rate charged
to the customer and the transfer price on that asset is
the net interest margin on that transaction attributable
to the business unit.
Components of Funds Transfer Pricing
The main components of Funds Transfer Pricing are
the asset spread, liability spread, and residual spread.
The asset spread (credit spread) is the net interest
margin earned by funds users, generated by
assets such as loans, investments, and fixed assets
that receive an FTP charge.
The liability spread (deposit spread) is the net
interest margin earned by funds providers on
products that provide funding for the
institution such as savings, certificate of deposits,
and institution borrowings that receive an FTP
credit.
The residual spread is the margin that assets and liabilities.
Treasury/Funds Management group earns
by ensuring adequate liquidity and managing The average cost method is easy to implement but
interest rate risk exposure and other risks. does not take into account the current costs and the
term structure of interest rates.
Methods For Funds Transfer Pricing
There are different approaches for FTP which is 2) Net Transfer Of Funds Method
prevalent like:
Based on net transfer of funds (difference between
1) Pooled/Average Cost Method assets and liabilities) between business units and
funding unit.
Based on average cost of all outstanding liabilities a
single transfer price rate is arrived at and used for all The net transfer of funds method (amount of
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BFSI Chronicle, 20th Edition March 2025
total assets and liabilities are netted out, without which is conducive to the complexity and the nature
considering the respective maturities) minimises the of business of that bank. The FTP methodology
complexity in the use of transfer pricing, but under employed in the banks should be consistent and
this the cost of interest rate and liquidity risk would transparent.There must be a mechanism for the
continue to impact the profits of the branch. branches and all business units to know on a periodic
basis how they are faring, on the basis of the defined
Another reason why using this method is not FTP framework vis-à-vis the budgeted targets.
appropriate is that the potential for assets and
liabilities may not be uniform for all business units
and therefore, the practice to net off would not be fair
and consistent for all the business units/branches.
3) Market Benchmark Linked Method
Based on prevailing market benchmark rates for
different maturities such as MIBOR, T-bill rate, G-sec
rate, transfer pricing curve is determined.
The market benchmark linked method provides
an objective basis to set the rates but would work
if the markets are liquid and competitive. In the
absence of borrowings of banks being linked to the
same benchmarks, the movement in the market
rates and cost of borrowings of the bank may not be
synchronised.
4) Matched Maturity Marginal Method
Based on incremental cost of raising funds for
different maturities. Under this approach,the rates
charged for the use of funds and rates credited for
providing funds are based on matching the maturity
of the asset and liability instruments to the FTP rate
that corresponds to that maturity and thus there is
segregation of the interest rate risk and liquidity risk
from the business unit profitability.
This method is more advantageous than other three
methods as it incentivises the bank to eliminate
costliest marginal funds so that threshold for lending
rate reduce and establishes threshold for each
decision to be profitable on an incremental basis.
Conclusion
It is important for every bank to have a robust and
well laid out Funds Transfer Pricing framework
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