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.