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Banking Essentials - Part I

This pathway will walk us through the basics of banks, starting with some of the different types and their main functions, then starting to look at the regulation faced by the banks, both before and after the Global Financial Crisis.

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Greenwashing is the act of distributing false information about something being more environmentally friendly than it actually is.

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Tackling the Cost of Living Crisis

In this video, Max discusses the cost-of-living crisis currently enveloping the UK. He examines its impact on households as well as the overall economy.

CSR and Sustainability in Financial Services

In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Funds Transfer Pricing Regimes

Funds Transfer Pricing Regimes

Moorad Choudhry

34 years: Banking and Capital Markets

In this video, Moorad delves deeper into the FTP methodology and describes how to apply it to specific commercial bank regimes.

In this video, Moorad delves deeper into the FTP methodology and describes how to apply it to specific commercial bank regimes.

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Funds Transfer Pricing Regimes

10 mins 1 sec

Overview

The concept of internal funds pricing and the term liquidity premium is quite a complicated one, and there is no "one size fits all". It is important that the mechanism put in place is the one most appropriate to the business model of the bank in question. The bank's FTP policy should always be owned by the Board, delegated to ALCO, and implemented by the Treasury and Finance departments.

Key learning objectives:

  • Learn the standard formulations of FTP for retail banks, corporate banks, and wholesale banks

  • Understand how to apply FTP methodology to commercial bank regimes

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Summary

What are the three template FTP Regimes?

Though there is no “one size fits all” FTP regime, we present here best practice guidelines for the FTP approach in retail, corporate and wholesale market business lines.

What is the Retail Bank FTP Regime?

A retail bank is stable funded, and in large part funded by zero or low-rate liabilities. The asset FTP tenor is generally set at less than the contractual tenor, at the expected life (EL) of the asset. This preserves a competitive position. Liabilities are also priced at behavioural tenor. So here FTP = TLP and not the cost of funds (COF).

For the floating rate asset, FTP is 3M Libor + TLP. The TLP tenor will be the behavioural life of the asset, so we have suggested 7-year as that is the average life of variable rate mortgages in the UK. For the fixed rate asset, FTP is the fixed rate equivalent to 3M Libor plus TLP where the TLP tenor matches the product life. This transfers interest rate risk from the business line and centralises it in Treasury, which is recommended.

The reality of FTP policy in retail banking is that it must reflect the two-way relationship between assets and customers. We can summarise that the practical considerations for FTP should reflect:

  • Actual rates paid by both sides of the balance sheet
  • Competitive position and the bank’s relative appetite for certain business lines
  • Properly priced products
  • And whether the bank applies assumptions around the behavioural maturity of its liabilities

What does the Corporate Bank FTP Regime consist of?

Compared to retail banking, corporate banking encompasses a wider range of products that attract FTP. In essence the FTP regime will be similar to that described for retail banks. Per the orthodox approach, business lines originating assets or raising liabilities will have funding and interest rate risk transferred to Treasury and made up to an equivalent interest basis. The key consideration here, which also applies in retail banking but to a lesser extent, is the hedging side, as a significant amount of corporate bank lending is at a fixed rate that must be hedged against interest rate risk. The bank’s IRR hedging policy document should influence product origination strategy, to ensure basis risk is minimised at the point of origination.

What would a Wholesale Bank FTP Regime include?

There is little, if any, concept of a “customer deposits” funding business and the asset side is typically funded with repo (secured funding) and wholesale funding (money markets, derivatives market making and capital markets). This makes the FTP model more straightforward to implement. For example, a summary template might look like this:

  • Trading book: funded in repo at the repo rate
  • Securitisable assets: origination of assets that are eligible for securitisation often receive a lower funding rate, a specified reduction in basis points, because they do not expose the bank to a need for more unsecured wholesale funding
  • Derivatives book: contractual and collateral funding cash flows are modelled into tenor buckets, as expected positive exposure (EPE) and expected negative exposure (ENE), with the net number (“expected exposure” or EE) charged or credited with the appropriate wholesale market COF, rather than the TLP

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Moorad Choudhry

Moorad Choudhry

Professor Moorad Choudhry is a non-executive director at two UK financial institutions, having worked in London since 1989. He has experience in wholesale capital markets, treasury, ALM, and balance sheet management. Moorad's most recent role was as divisional treasurer at the Royal Bank of Scotland. He has also worked with Europe Arab Bank, KBC Financial Products, and JP Morgan. He is the author of "The Principles of Banking," which is currently in its 2nd edition.

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