Gauge All True Costs


Leverage funds transfer pricing to drive profitability

By Kenneth M. Levey

As community bankers evaluate the most effective ways to achieve their profitability goals, the importance of calculating and tracking funds transfer pricing (FTP) should not be overlooked. Traditionally, FTP, a process used to evaluate the performance of a bank’s different activities and operations, has been used in some capacity to help financial institutions better determine the profitability of individual customers, products, organizational units and channels. But typically, banks are not leveraging FTP to its fullest potential.

As executives of financial institutions try to determine key drivers amongst compressed margins and increasing competition, clearly and comprehensively understanding their bank’s net interest margin prepares them to make more informed decisions and determine product pricing. In today’s market, community banks need a sound approach to calculating FTP to clearly understand their profit margins throughout every level of the organization.

Using the industry’s most accepted methodology, the matched-funding approach to calculate the FTP rate requires looking at the cash flow characteristics of the account (for example, an auto loan will be amortized over its projected life at origination). Each principal cash flow is time weighted by the period it is to run off and then multiplied by the FTP yield curve at origination. All those weighted numbers are then combined into a single FTP rate. It is vital that it include appropriate assumptions reflecting the characteristics of an institution’s products, such as FTP rates, an FTP yield curve and spread adjustments. When used correctly, FTP can measure each individual account based on a specific product’s characteristics.

Once a stable FTP process has been established, banks should aim to ensure that their FTP reporting extends beyond traditional accounting metrics and includes analytical analysis specific to the bank. Although traditional reporting has included account balances, rates, FTP rates and FTP spreads, by incorporating other information (such as customer credit scores), banks can better determine who is practicing risk-based pricing on a departmental, loan officer and channel level. If reports show no measurable distinction between higher and lower credit quality of loans, it reveals the bank’s lack of correlation between its pricing and risk.

To further maximize the benefit of FTP, community banks also should consider using historical results along with current pricing decisions. Although understanding a bank’s current portfolio activity is paramount, much can be learned by analyzing historical trends. For example, these data can reveal whether a currently underperforming officer (or department or line of business) has a history of bad performance or if a recent slump in profitability is attributable to some other market or business conditions.

Additionally, community banks can gain a greater ability to forecast future performance by analyzing a deposit or loan portfolio’s runoff over a selected time horizon. These data equip banks to more intelligently analyze what “new spreads” are needed to either maintain or grow profitability.

Leveraging these processes and analytics holistically through one unified enterprise performance management platform provides greater value for using an FTP system. Clearly understanding and appropriately implementing these practices into FTP reporting present a greater opportunity for banks to grow their various profitability margins.