Funds Transfer Pricing: The Basics
Funds transfer pricing, or FTP, is a common framework maintained by Bank Treasury that supports profitability measurement, pricing and risk management. Specifically, the FTP methodology ascribes value and cost to sources and uses of bank funding, respectively. Deposit-generating businesses are credited for the funding they provide, with FTP credits that can be considered interest revenue or “for deposits. Conversely, loan-generating businesses are charged for their use of bank funding, with FTP charges that can be considered loan interest expense or cost of funds. When combined with customer-facing interest rates, these FTP credits and charges produce FTP-adjusted margins that provide a profitability signal to the bank, and thereby inform business pricing and investment.
FTP credits and charges are determined based on the interest rate sensitivity and liquidity characteristics of underlying customer balances. For products with behavioral elements or embedded optionality – for example, non-maturity deposits or loans with prepayment or refinance options – banks need to perform behavioral analysis to understand these characteristics, which can be influenced over time by market and competitive dynamics. For deposits, here are the three relevant behaviors to track:
Repricing Beta
Expected Life
Stressed Liquidity
What is the sensitivity of deposit rates paid to changes in short-term market interest rates?
How investible for the long term are deposit balances given long-term liquidity life on the balance sheet?
What portion of balances should be considered investible only for the short term given volatility or the potential for sudden outflows?
The funding value (or quality) of deposits varies considerably by deposit segment—with more stable, less rate-sensitive segments such as checking or operating accounts receiving higher FTP credit and less stable, more rate-sensitive segments such as commercial non-operating balances receiving lower FTP credit.
Current Complications
Not surprisingly, FTP has been a topic of great interest in 2022 and 2023, and there are three main reasons why:
- The effects of sustained high inflation on COVID-era surge balances
- The effects of the high and still-rising interest rate environment on customer balance behavior
- Most recently, the impact of headline-making bank failures on banks’ attitudes toward both deposit stickiness and demand for deposit liquidity.
Because these developments significantly affect depositor behavior, they also significantly affect the quality of deposits and therefore FTP value. Let’s take a closer look at each.
First, as a result of the rapidly rising interest rate environment, observed repricing betas are in some cases higher than assumptions used in FTP. This is particularly true for institutions with higher concentrations of rate-based deposit segments, such as consumer online and brokerage/wealth. It’s also true for commercial non-operating balances, especially those held by institutions with a high urgency to retain balances, such as those needed to fund held-to-maturity securities portfolios with unrecognized losses.
Second, as a result of rising rates and inflation, deposit lives are shortening. While this is true across the board, it is especially the case, again, for commercial rate-based deposits. According to balance decay analysis of account-level deposit data from Curinos Deposit Analyzer, which covers more than $7 trillion in U.S. deposit balances, weighted-average lives (WALs) have shortened considerably for consumer and commercial non-operational savings balances since the beginning of 2022.
12M Trailing WAL vs. Fed Funds Target
Third, in light of U.S. bank liquidity events that saw outflows of more than 20% of total deposits in a single day, banks are, or should be, carefully reexamining the portion of balances that must be held in cash or other high-quality liquid assets to support potential stressed outflows. The “usual suspects,” such as financial-institution or non-operational corporate balances held by thin-relationship depositors, are under the microscope. But because social media and improved online account opening can accelerate outflows, we believe a broader review is warranted, and reliance on broad-brush regulatory assumptions should be replaced with internal liquidity-stress-testing analytics. Analysis of Curinos Deposit Analyzer data showed, for example, that outflows were on average three to four times higher for wealth and commercial deposit segments than for the consumer segment in the week immediately following the collapse of Silicon Valley Bank.
Average Weekly Balance Change By LOB: Deposit Analyzer Participants
Generally, these developments have been raising the interest sensitivity and lowering the long-term liquidity value of deposits—in effect shortening deposit duration – which from a risk-management standpoint, is an important dynamic to capture. Treasury typically accomplishes this through asset/liability modeling, which produces interest rate risk metrics that inform balance sheet management and hedging decisions. In this context, deposit duration shortening clearly should be factored into understanding the bank’s forecasted asset sensitivity.
Through FTP, however, deposit duration shortening sends a profitability/pricing signal to the deposit-gathering businesses that may not be particularly helpful. This is especially true for banks that have a heightened demand for funding because of deposit-outflow pressures, impaired HTM securities portfolios or a combination of the two.
Key Considerations Looking Forward
With the spotlight on deposits and FTP, bank treasury functions should work to ensure that FTP methodologies are capturing the funding value of deposits accurately. They should also implement safeguards to address instances in which the real-time funding value of deposits may be in conflict with broader enterprise objectives for deposits. Here are three specific priorities to consider:
First, deposit FTP should be configured in a way that segments customer deposit pools where there are measurable differences in behaviors that correspond with value. This begins with capturing distinct customer types. As the recent banking crises showed, there were marked differences in outflows from wealth and commercial deposits versus those from consumers. Better-practice banks are taking this segmentation a step further by layering in the depth of a customer relationship and by crediting core, multi-relationship customer balances differently than thin-relationship customers.
Second, customer behaviors should be measured, and even updated, more frequently, especially in dynamic market environments. To make this work, banks should embrace key performance/risk indicator measurement that is behavior-based and take into account formal governance processes. Relying on years-old assumptions or reviewing assumptions updated annually risks missing important changes in customer behavior that drive changes to a bank’s risk profile.
Third, banks should understand when FTP signals are misaligned with enterprise objectives. A good example is when deposit FTP credits are not providing an incentive to drive deposit growth in core relationship products such as checking or operational accounts, when such growth is embedded in the organization’s strategic objectives. In these cases, again, a formal governance process of putting in place strategic management overlays to FTP need to exist. Further, adjustments to FTP credits must clearly break out base rates, liquidity premiums and contingent liquidity charges from strategic qualitative adjustments that management may make.
Funds transfer pricing is an essential component of risk management and profitability measurement, and the recent market turmoil has only shone an even brighter light on its its criticality. Especially in today’s volatile environment, banks need to understand the mechanics and value of FTP and to adjust and enhance their processes and approaches to managing deposits accordingly, and with the speed demanded by a rapidly changing environment.
