Bank Regulators Offer Guidance on Funds Transfer Pricing
Commentary by Steven Lofchie
The FDIC, the Board of Governors of the Federal Reserve System and the OCC issued interagency guidance to clarify supervisory expectations for an effective funds transfer pricing ("FTP") framework. The guidance outlines four principles designed to help large financial institutions develop and maintain an effective FTP framework.
Principle 1. A firm should have an FTP framework that allocates costs and benefits based on (i) funding risk and (ii) contingent liquidity risk. The cost of financing operations, or benefit of holding standby liquidity, may depend on the characteristics of funding sources and uses.
Principle 2. The methodologies of the FTP framework should be transparent, repeatable and sufficiently granular to align business decisions with overall funding and contingent liquidity risk appetites.
Principle 3. A firm should maintain a senior management group that oversees FTP and establish a central management function tasked with implementing the FTP framework.
Principle 4. Through its FTP framework, a firm should incorporate FTP costs and benefits into product pricing, business metrics, and new product approval for all material business lines, products and activities – both on and off the balance sheet.
The guidance also contains an attachment that describes FTP methodologies that a firm may consider when implementing the framework.
Commentary
The guidance notes: "Through [a sound method of allocating internal funding], a firm can transfer these risks to a central management function that can take advantage of natural offsets, centralized hedging activities, and a broader view of the firm." The irony of the wording is that current financial regulation often forces firms to segment their operations, including funding, in wholly irrational ways in order to conform them to the regulatory structure. Divisions between securities and futures, loans and debt instruments - notwithstanding regulators' nostalgia for Glass-Steagall - makes no economic sense. Forcing a firm to divide similar activities among different legal entities creates new risks that result in the firm becoming less well-managed as a whole. One of the lessons of the Lehman/Bear Stearns/AIG failures was this: risk must be managed at the holding company level. Despite that lesson, post-crisis rulemaking continues to segment activities in nonsensical ways.