Funds transfer pricing · RiskAtoms Academy

By the end you will be able to

1Price a product with a matched-maturity transfer rate and say what margin the business keeps.
2Explain how FTP moves interest rate risk from the business lines to ALM, and why charging the overnight rate does not.
3Split the bank's NII into business margins and the treasury's result, and show who carries a rate shock.
4Explain how the structural hedge's result reaches the deposits through replicating-portfolio crediting.

Why it matters

Rates fall 275bp. RiskAtoms Bank's net interest income drops £263.3m in the first year. Inside the bank, depending on how the treasury prices money, the retail business reports a fall of £644.5m and the treasury a gain of £508.6m, or retail £348.4m and treasury £212.5m. The bank is the same and so is the loss. What differs is who is told it is their fault, and so who will try to fix it. Funds transfer pricing is how a bank answers that before the shock, not after.

Core explanation

Selling the rate risk to the treasury

Illustrative dataRiskAtoms Bank plc's banking book

The same £67bn balance sheet as Module 3.5, on one made-up reporting date, in pounds, with how each line reprices, its customer rate, a SONIA curve with Bank Rate at 4.00%, a £19.2bn macro hedge on the fixed-rate mortgages and a £16bn structural hedge. Tier 1 capital is taken as £3.5bn. The figures are round illustrative values, not any bank's data. Every lesson in Module 3.6 uses this book, so the figures agree.

Extra for this lesson: which business owns each line, and the transfer rate each fixed product was written at. The fixed-rate mortgages take the macro hedge's swap rates (3.9% and 3.0%); other fixed products are taken as written recently, at today's rate for their term. All transfer rates here are risk-free: the liquidity premium of L3.5.11: Pricing liquidity is left out.

L3.5.11: Pricing liquidity built the transfer price as a base rate at the product's interest tenor, plus a liquidity premium at its liquidity tenor, plus a contingent charge. This lesson is about the first part: the base rate, and what it does to interest rate risk. Under matched-maturity FTP every product is bought by the treasury at the swap rate for its own repricing term, fixed on the day it is written. A five-year fixed mortgage is charged the five-year swap rate for five years; a tracker or a current account is charged or credited the overnight rate, which moves with Bank Rate.

ExploreOne new mortgage through the treasury

Click a box to see what happens there.

Retail writes it

The retail bank lends £1bn of five-year fixes at 4.99%: today's five-year swap rate, 4.29%, plus its product margin of 0.70%.

The point is the split. The business is paid for what it is good at, lending at a margin over the market rate (the commercial margin). The rate mismatch goes to one place, the treasury, where ALCO can see it whole, net it across the bank and hedge what is left. Charge the mortgage the overnight rate instead and the business shows £9.9m a year today, and a loss of £17.6m if rates rise 275bp: a lending business judged on a rate bet it cannot see or hedge.

The book through FTP

Every customer line gets a transfer rate. The treasury owns everything else: the liquid assets, the wholesale funding, the equity and both hedges. Today's £1,585.2m of NII splits like this, with current accounts credited the overnight rate:

Line	Business	Balance	Customer	Transfer	Spread	Margin a year
Two-year fixed-rate mortgages	Retail	£9.0bn	4.60%	3.90%	+70bp	+£63.0m
Five-year fixed-rate mortgages	Retail	£15.0bn	3.80%	3.00%	+80bp	+£120.0m
Tracker mortgages (Bank Rate + 0.75%)	Retail	£3.0bn	4.75%	4.00%	+75bp	+£22.5m
Standard variable rate mortgages	Retail	£3.0bn	6.75%	4.00%	+275bp	+£82.5m
Floating-rate corporate loans (SONIA + 1.8%, quarterly resets)	Corporate	£10.0bn	5.80%	4.00%	+180bp	+£180.0m
Fixed-rate corporate term loans	Corporate	£2.0bn	5.60%	4.22%	+138bp	+£27.7m
Personal loans (fixed)	Retail	£2.5bn	7.00%	4.22%	+278bp	+£69.6m
Credit card balances	Retail	£1.0bn	12.00%	4.00%	+800bp	+£80.0m
Personal current accounts	Retail	£22.0bn	0.50%	4.00%	+350bp	+£770.0m
Instant-access savings	Retail	£10.0bn	3.00%	4.00%	+100bp	+£100.0m
Retail fixed-term deposits	Retail	£6.0bn	4.10%	4.09%	−1bp	−£0.5m
Operational corporate deposits	Corporate	£5.0bn	1.00%	4.00%	+300bp	+£150.0m
Corporate call accounts	Corporate	£3.0bn	3.50%	4.00%	+50bp	+£15.0m
Corporate term deposits	Corporate	£2.5bn	3.50%	3.97%	+47bp	+£11.6m
Treasury (ALM) result						−£106.2m

The treasury's result is negative today, −£106.2m, because it holds the back books. The five-year fixes were transferred at 3.0% when they were written; Bank Rate is now 4.00%. Their 80bp margin still belongs to retail. Also notice the retail term deposits: on rates alone they earn −0.8bp, because the bank pays slightly above the one-year swap rate. They earn their keep through L3.5.11: Pricing liquidity's liquidity credit, 42.9bp for one-year money.

Who carries a shock

Run the book's year-1 NII through the same split. Fixed-rate and floating products barely move: their margins were matched. The deposits do move. A current account's customer rate changes by a tenth of Bank Rate while its overnight credit changes one for one, so with overnight crediting the deposit margin falls £547.9m in a 275bp fall. Retail carries the deposits' rate risk and the treasury holds the structural hedge that offsets it: two volatile results that cancel only at group level.

Business	Today, overnight crediting	Year 1, −275bp	Year 1, +275bp	Today, replicating	Year 1, −275bp, replicating
Retail	£1,307.1m	−£644.5m	+£644.5m	£1,259.1m	−£348.4m
Corporate	£384.3m	−£127.4m	+£127.4m	£384.3m	−£127.4m
Treasury (ALM)	−£106.2m	+£508.6m	−£517.2m	−£58.2m	+£212.5m
The bank	£1,585.2m	−£263.3m	+£254.7m	£1,585.2m	−£263.3m

Sharing the structural hedge's result

The fix is to credit the hedged deposits with the hedge's own yield. The £12bn of current accounts that the structural hedge covers are credited a replicating portfolio: the same five-year ladder, yielding 3.60% today; the rest is credited overnight. The current accounts' blended credit falls from 4.00% to 3.78% and their margin from £770.0m to £722.0m today, but in a 275bp fall it drops only £251.8m instead of £547.9m. On that £12bn block the treasury now pays retail the ladder rate and receives the ladder rate from the swaps: it is flat. The £4bn of equity in the hedge has no business to credit, so its result stays with the treasury (some banks pass it on to the businesses in proportion to the capital they use).

Three ways to get it wrong

The formal version

For customer product $j$ with balance $A_j$ , customer rate $r_j$ , transfer rate $f_j$ and sign $s_j$ (+1 for assets, −1 for deposits):

\begin{aligned} f_j &= S(T_j) = \frac{1 - \text{DF}(T_j)}{\sum_{i=1}^{T_j} \text{DF}(i)} \quad \text{(fixed for } T_j \text{ years, set when written)} \\ m_j &= s_j\,A_j\,(r_j - f_j) \\ \text{NII} &= \sum_j m_j + R_{\text{T}}, \qquad R_{\text{T}} = \text{NII} - \sum_j m_j \\ \Delta\text{NII} &= \sum_j \Delta m_j + \Delta R_{\text{T}} \quad \text{(the same total under any FTP)} \\ f_{\text{rep}}(t) &= \bar r(t) = \frac{1}{N}\sum_{k=1}^{N}\Big[\mathbf 1(t_k > t)\,r_k + \mathbf 1(t_k \le t)\,r^{\text{new}}\Big] \end{aligned}

$S(T)$ is the par swap rate with annual payments ( $S(1) = 4.09\%$ , $S(3) = 4.22\%$ , $S(5) = 4.29\%$ on the book's curve); terms under a year use the money-market rate (three months: 3.97%). $R_{\text{T}}$ is the treasury's result and $f_{\text{rep}}$ the replicating credit, the structural ladder's yield from L3.6.10: Hedging the banking book. For the current accounts today:

\begin{aligned} f_{\text{PCA}} &= \tfrac{12}{22} \times 3.60\% + \tfrac{10}{22} \times 4.00\% = 3.782\% \\ m_{\text{PCA}} &= 22{,}000 \times (3.782\% - 0.50\%) = \text{£}722.0\text{m} \end{aligned}

Try it

Choose a shock, a crediting method for current accounts and whether the structural hedge runs. The bars show each business's change in year-1 NII and the bank's.

Try itWho carries the rate risk?

Rate shock

Current accounts credited at

Structural hedge

Retail, year 1 base£1,307.6m

Corporate, year 1 base£384.3m

Treasury (ALM), year 1 base−£51.0m

Bank NII, year 1 base£1,640.9m

Current accounts' margin change−£547.9m

Bank's change (any FTP)−£263.3m

Switch the crediting method and the bank's total does not move: FTP changes who reports the change, not the change. Credit current accounts with the replicating portfolio and switch the structural hedge off: Treasury has promised retail a fixed-rate credit it has not hedged, and now it is Treasury that loses when rates fall.

Worked example

One mortgage, three ways to price it

£1bn of five-year fixes, then rates rise 275bp

Step 1 of 5

1
The deal
Customer rate 4.99% = five-year swap 4.29% + margin 0.70%. Overnight rate 4.00%.

What ALCO sees

With matched-maturity FTP, the £263.3m year-1 loss in a 275bp fall comes from the deposit margins, with the treasury's hedges winning part of it back; the lending margins hardly move. Credit the hedged current accounts with the replicating portfolio and retail's hit falls from £644.5m to £348.4m.

Regulatory lens

The liquidity side of FTP has its own rules, covered in L3.5.11: Pricing liquidity: Basel's 2008 Principle 4 and the CEBS 2010 guidelines. On the interest side the IRRBB rules care about the commercial margins that FTP separates out. The EBA's 2022 guidelines ask banks to define commercial margins and set out how they are treated internally, and say that NII measures of IRRBB should include them; EVE may include or exclude them, provided the method is transparent and consistent. The IRRBB rules in detail come in M4.5: Liquidity and IRRBB regulation; building FTP curves, including the behavioural models behind replicating portfolios, is M6.7: Liquidity, ALM and behavioural models.

Spark Atoms

Spark AtomThe back book's loss lives in the treasury

Today the treasury reports −£106.2m while retail reports £1,307.1m. The five-year fixes still earn their 80bp margin because they were transferred at 3.0%, the swap rate when they were written. The macro hedge pays that same 3.0%, so the bank as a whole is protected; the gap between old fixed rates and today's Bank Rate sits in one place, where it can be seen.

Spark AtomSame bank, different heroes

In a world of falling rates, overnight crediting makes the deposit business look as though it is collapsing and the treasury look brilliant. Under replicating crediting both look steady. Neither picture changes the bank's total; both change who gets promoted.

Key takeaways

Matched-maturity FTP charges or credits each product the swap rate for its own repricing term, fixed when it is written; the business keeps the commercial margin.
The rate mismatch moves to the treasury (ALM), which nets it across the bank and hedges what ALCO does not want to keep.
FTP splits NII without changing it: today £1,307m retail, £384m corporate and −£106m treasury make the bank's £1,585m.
Crediting deposits overnight leaves the rate risk of current accounts in retail; crediting the structural hedge's ladder yield passes the hedge's stable income to the deposits and cuts retail's hit in a 275bp fall from £644m to £348m.
A replicating credit is a promise: if the treasury credits it, the treasury must hedge it.

Reaction

Check what stuck

Question 1 · objective 1

A business writes a three-year fixed-rate loan at 6.0% when the three-year swap rate is 4.2%. Under matched-maturity FTP, what margin does the business keep, in basis points?

bp

Question 2 · objective 2

Rates rise 200bp the day after that loan is written. Under matched-maturity FTP, who loses if nothing is hedged?

AThe business, because the loan's rate is now below marketBTreasury, because it pays the business's funding at the new, higher short rate while receiving the fixed transfer chargeCNobody, because the loan is fixedDThe customer

Question 3 · objective 3

£10bn of current accounts pay 0.5% and are credited a replicating portfolio yield of 3.0%. What margin does the deposit business earn a year, in £m?

£m

Question 4 · objective 3

Under overnight crediting, a 275bp fall cuts Retail's year-1 margin by £644.5m; under replicating crediting, by £348.4m. The bank's total change is −£263.3m either way. What has changed?

AThe bank's risk has fallenBOnly who reports the change: replicating crediting passes the structural hedge's stable income to the deposits, and Treasury, which holds the hedge, reports less of the gainCThe deposits now pay customers moreDThe structural hedge has been closed

Question 5 · objective 2

A five-year fixed mortgage at 5.00% is charged the overnight rate instead of a matched-maturity rate. Overnight goes from 4.00% to 6.75%. What margin does the business now show, in basis points? (Use a minus sign for a loss.)

bp

Glossary

Matched-maturity FTP: Matched-maturity FTP: each product is charged or credited the market rate for its own repricing term, fixed when the product is written, so its margin does not change while its rate is fixed.
Transfer rate: Transfer rate: the internal rate at which Treasury buys a business's assets and deposits. On the interest side it is a risk-free swap rate for the product's repricing term.
Business margin: Business margin: customer interest less the transfer charge (for loans) or the transfer credit less customer interest (for deposits).
Treasury (ALM) result: Treasury (ALM) result: what is left of net interest income after the business margins, made up of the bank's own mismatch, its hedges and its liquid assets and wholesale funding.
Replicating portfolio: Replicating portfolio: a ladder of fixed-rate investments chosen to behave like a deposit's stable balance; the deposit is credited the ladder's yield.
Back book and front book: Back book and front book: loans written in the past at past rates, and new lending written at today's rates.
Commercial margin: Commercial margin: the spread a customer pays over (or receives under) the risk-free rate; it belongs to the business, not to the interest rate risk.

Deep Dives & Origins

Deep Dives

Financial Stability Institute, Liquidity transfer pricing: a guide to better practice, FSI Occasional Paper No 10, Bank for International Settlements, December 2011. Intermediate.
European Banking Authority, Guidelines on IRRBB and CSRBB (EBA/GL/2022/14), October 2022, on commercial margins and internal governance. Advanced.

Origins

European Banking Authority, Guidelines on IRRBB and CSRBB, EBA/GL/2022/14, 20 October 2022, paragraphs 47(m), 67(c), 81 and 82.
Financial Stability Institute, Liquidity transfer pricing: a guide to better practice, FSI Occasional Paper No 10, BIS, December 2011.

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