TAKEAWAYS
Increasing market volatility, inflation, cost of funding, and market illiquidity have placed banking CFOs and their treasurers under growing pressure to reassess the effectiveness of their fund transfer pricing (FTP) mechanisms, and the accuracy with which they are evaluating, managing, and charging the various business units.
Compounding this challenge are also several emerging factors impacting FTP base rates, such as the transition from Interbank Offered Rates (IBOR) to alternative risk-free rates (RFRs) that do not reflect term structures, as well as inherent uncertainties surrounding the maturity timelines and volume development of non-maturing deposits (NMDs), which are growing in importance as a cost-efficient source of funding for many banks.
While there are no one-size-fits-all FTP approaches, a best-in-class framework is one that is fundamentally commensurate with the bank’s activities and size.
Leveraging our extensive experience supporting banking CFOs and their treasurers in evolving their FTP mechanisms, we have distilled our learnings into three key design themes for a best-in-class FTP framework:
1) Strategic alignment: There needs to be strategic alignment between the FTP mechanism and the bank’s overarching financial resource management objectives. This is critical to ensuring that the FTP mechanism serves its purpose in driving balance sheet objectives and optimising financial resource allocation and consumption. To this end, we have identified three additional design principles.
First, there needs to be a review of the business model and balance sheet objectives that the bank is looking to achieve, as well as definition of economic performance units (EPUs) to establish the strategic objectives of the FTP framework; second, liquidity portfolio optimisation and risk management strategies will need to be analysed under realistic but stressed scenarios; and third, treasury risk management must tailor hedging structures to the bank’s business model.
2) Consistency and feasibility: The FTP framework needs to be clearly articulated, transparent, and easily understood by business units. Furthermore, it should be effective across both the banking book and trading book, and be consistently applied at the group level in the pricing of similar currencies across different markets.
3) Technical soundness and feasibility: Given that the FTP framework serves as the technical basis for the determination of the tenor of funding requirements, there needs to be conceptually sound and feasible approaches to establishing base rates and liquidity premiums, as well as allocating costs, for the bank to derive a true view of the product or portfolio’s economic value against prescribed minimum performance returns on allocated or risk-based capital.
To accelerate the gap analysis process, easily identify quick wins, and comprehensively articulate desired target states, we have developed a granular maturity model to facilitate structured benchmarking discussions on FTP capabilities along five dimensions:
1) Governance and organisation: Mature FTP frameworks should clearly define the policies, roles, and responsibilities at the bank’s group, regional, and divisional levels along the three lines of defence (3-LoD) and receive the endorsement of senior stakeholders.
2) Processes and control: Mature FTP framework and asset liability management (ALM) mandates should be supported by robust processes and a comprehensive set of internal controls that are effective, efficient, and fully documented along the 3-LoD. FTP processes should also be seamlessly integrated into the bank’s business decision-making capabilities, particularly as they relate to transaction and deal pricing, funding, liquidity management, and forecasting and budgeting.
3) Models: Apart from being capable of supporting the business-as-usual activities of a bank, mature FTP models should be able to withstand stress testing and scenario analysis planning as mandated by business and regulatory requirements. The model strategy should also be fully documented, and subject to comprehensive controls and validation to ensure clear delineation between LoD 1 and LoD 2.
4) Systems and data: In a mature setup, a comprehensive architecture of IT systems should be in place to support robust and accurate data aggregation, calculation, and reporting of FTP-relevant data. The system architecture should also be accompanied by robust data quality controls and service-level agreements covering data flow and system functionality aspects.
5) Management information systems (MIS) and reporting: In order to serve as a basis for effective decision making, the MIS and reporting system should cater to the information needs of senior management and include data visualisation tools for them to obtain a comprehensive understanding of the amount, evolution, and drivers of profit and loss (P&L) and funding risks within the bank.
As CFOs and their treasurers deliberate on how they can design robust, future-proof FTP frameworks amid the increasingly uncertain market environment, we would like to conclude with three key success factors that we believe they would do well to keep in mind.
Firstly, there is a critical need for a more in-depth and practical understanding of how FTP integrates with financial resource management, particularly in relation to capital allocation and performance metrics. The inability to apply a fuller and more reflective economic cost-of-funding reallocation perspective to the design of an FTP framework could result in the incentivisation of non-strategic behaviours at the expense of others.
Secondly, CFOs and their treasurers should focus on delta and embrace quick wins. A focus on developing overly detailed blueprints is not only time-consuming, it runs the risk of over-engineering and loss of stakeholder commitment. The key lies in identifying the maximum benefit profile and focusing on critical areas to enhance balance sheet management.
Finally, a successful FTP framework is one that is embraced by its stakeholders. Sufficient time and resources must be factored in for the relevant engagement and socialisation activities to bring stakeholders along the journey. In the longer term, there is also the need to forge closer working alliances between the treasury, finance and risk functions, as well as business units, to ensure that FTP framework components remain reflective of full end-to-end costs.
Looking ahead, the bottom line is that FTP mechanisms can no longer be a passive below-the-line cost-allocation process. Rather, they need to become dynamic processes with the buy-in – or even challenge – from critical stakeholders to drive the optimisation of a bank’s balance sheet and P&L performance.
Wayne Savage is Financial Services Industry Assurance Leader, Deloitte Southeast Asia; and Dishell Gokaldas is Algorithmic & Quantitative Assurance Leader, Deloitte Southeast Asia.
© 2024 Institute of Singapore Chartered Accountants
