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From Banking and Finance Law Daily, March 2, 2016

Interagency guidance clarifies supervisory expectations for funds transfer pricing framework

By Andrew A. Turner, J.D.

The Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency have issued guidance on funds transfer pricing (FTP) practices related to funding risk (including interest rate and liquidity components) and contingent liquidity risk at large financial institutions to address weaknesses observed in some firms’ FTP practices. The interagency guidance is applicable to national banks, federal savings associations and state-chartered banks with consolidated assets of $250 billion or more, domestic bank and savings and loan holding companies with consolidated assets of $250 billion or more or foreign exposure of $10 billion or more, and foreign banking organizations with combined U.S. assets of $250 billion or more (OCC 2016-7SR 16-3FIL-12-2016).

FTP is a tool for managing a firm’s balance sheet structure and measuring risk-adjusted profitability. By allocating funding and contingent liquidity risks to business lines, products, and activities within a firm, FTP influences the volume and terms of new business and ongoing portfolio composition. FTP is also a tool for centralizing the management of funding and contingent liquidity risks for all exposures. The OCC noted that the 2008 financial crisis exposed weak risk management practices for allocating liquidity costs and benefits across business lines.

An institution should effectively apply FTP to align risk-taking incentives of individual business lines with the firm’s overall risk appetite. The interagency guidance describes four key principles that should comprise an FTP framework and includes examples for implementing these principles. A firm should:

  • allocate FTP costs and benefits based on funding risk and contingent liquidity risk;
  • have a consistent and transparent FTP framework for identifying and allocating FTP costs and benefits on a timely basis and at a sufficiently granular level, commensurate with the firm’s size, complexity, business activities, and overall risk profile;
  • have a robust governance structure for FTP, including the production of a report on FTP and oversight from a senior management group and central management function; and
  • align business incentives with risk management and strategic objectives by incorporating FTP costs and benefits into product pricing, business metrics, and new product approval.

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