Banking: Modeling Methodology
SEPTEMBER 2011
MODELING METHODOLOGY
Authors
Robert J. Wyle, CFA Yaakov Tsaig, Ph.D
Implementing High Value Funds Transfer Pricing Systems
Abstract
Funds transfer pricing (FTP) is the process through which banks allocate earnings to the various lines of business in which they are engaged. The realization that FTP is an important part of enterprise risk mitigation has sparked new interest in this technique, both in regulatory publications and industry findings. Like any other complex control system, a large body of FTP practices has evolved over time. In this paper, we explore traditional FTP approaches and highlight best practices in FTP methodologies and implementation. We advocate an economic approach when calculating transfer prices, which accounts for the financial risks inherent in an exposure. We emphasize the importance of designing an FTP framework that addresses funding liquidity risk, in light of recent economic events, with increased focus on liquidity management. We demonstrate how an economic approach can be used as a means of disaggregating a transfer price into different components and associating appropriate premia to each component. This decomposition facilitates risk transfer between the funding unit and the various business lines in a manner that aligns the financial incentives of the different units. We point to the linkages between FTP and risk-adjusted performance measurement, and suggest that an economic FTP framework can be viewed as a bridge between risk-based pricing and commercial pricing.
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2
Table of Contents
1 2 Introduction ...........................................................................................................................................................
MODELING METHODOLOGY
Authors
Robert J. Wyle, CFA Yaakov Tsaig, Ph.D
Implementing High Value Funds Transfer Pricing Systems
Abstract
Funds transfer pricing (FTP) is the process through which banks allocate earnings to the various lines of business in which they are engaged. The realization that FTP is an important part of enterprise risk mitigation has sparked new interest in this technique, both in regulatory publications and industry findings. Like any other complex control system, a large body of FTP practices has evolved over time. In this paper, we explore traditional FTP approaches and highlight best practices in FTP methodologies and implementation. We advocate an economic approach when calculating transfer prices, which accounts for the financial risks inherent in an exposure. We emphasize the importance of designing an FTP framework that addresses funding liquidity risk, in light of recent economic events, with increased focus on liquidity management. We demonstrate how an economic approach can be used as a means of disaggregating a transfer price into different components and associating appropriate premia to each component. This decomposition facilitates risk transfer between the funding unit and the various business lines in a manner that aligns the financial incentives of the different units. We point to the linkages between FTP and risk-adjusted performance measurement, and suggest that an economic FTP framework can be viewed as a bridge between risk-based pricing and commercial pricing.
Contact Us
Americas +1-212-553-1653 clientservices@moodys.com Europe +44.20.7772.5454 clientservices.emea@moodys.com Asia (Excluding Japan) +85 2 2916 1121 clientservices.asia@moodys.com Japan +81 3 5408 4100 clientservices.japan@moodys.com
2
Table of Contents
1 2 Introduction ...........................................................................................................................................................
References: Copyright © 2011 Moody 's Analytics, Inc. and/or its licensors and affiliates. All rights reserved. Basel Liquidity Risk Working Group, 2008, Principles for Sound Liquidity Risk Management and Supervision. Bessis, Joel, 2002, Risk Management in Banking, Second Edition, John Wiley & Sons, LTD. Ernst & Young LLP, 1995, Performance Measurement for Financial Institutions: Methods for Managing Business Results, McGrawHill. Kawano, Randal T., 2000, “Funds Transfer Pricing,” The Journal of Cost & Management Accounting. Matz, Leonard, 2007, Liquidity Risk Measurement and Management, John Wiley & Sons. Rout, Robert E., Mark Kochvar, 2000, “Transfer Pricing: A Poor Man’s Approach,” The Journal of Cost & Management Accounting. Senior Supervisors Group, 2008, Observations on Risk Management Practices during the Recent Market Turbulence. Shih, Andre, David Crandon, Steven Wofford, 2000, “Transfer Pricing: Pitfalls in Using Multiple Benchmark Yield Curves,” Journal of Cost & Management Accounting. Unknown author, “Assignment of Contribution for Funds Transferred Internally,” Journal of Cost & Management Accounting. Unknown author, 2001, “Introduction to Funds Transfer Pricing,” The Journal of Cost & Management Accounting. Whitney, Cole T., Woody Alexander, 2000, “Funds Transfer Pricing: A Perspective on Policies and Operations,” The Journal of Cost & Management Accounting. Young, H. Walter, Steven W. Reiter, 2000, “Bottom Line Profitability: Measuring the Risk Components within a Corporate Treasury Funding Center,” Journal of Cost & Management Accounting. IMPLEMENTING HIGH VALUE FUNDS TRANSFER PRICING SYSTEMS 19