A retail branch books a 30-year mortgage at 7%. The Treasury desk borrows overnight at 5% to fund it. On a quarterly P&L, the branch reports a 2% spread; the Treasury desk reports a flat margin. When rates rise 100 basis points, overnight funding goes to 6% and the Treasury margin turns negative; the branch still shows 7%. Without funds transfer pricing, the branch never sees the duration risk it created. The interest-rate gap sits in Treasury, and Treasury cannot turn it off.
Without FTP, business lines see only their direct revenue and direct cost. A retail mortgage desk earning 7% on a 30-year loan reports a healthy spread because the funding cost shows up on Treasury's books, not the desk's. The desk has no reason to care whether rates rise: it locked in the 7% asset rate and never sees the floating funding cost.
The result is misaligned incentives. Loan officers pile into long-duration assets because the headline yield is high. Deposit gatherers ignore liability tenor because they earn a flat fee.
Common mistakes
- Treating zero-cost FTP as adequate. Charging business lines nothing for funding causes systematic over-extension into long-dated assets and short-dated deposits. The FSB explicitly identified zero-cost FTP as a contributor to pre-2008 fragility. Trap: a question describes a bank using "no internal funding charges" and asks whether the practice is sound: the answer is no.
- Confusing FTP rate with the bank's actual funding cost. FTP uses a market-curve-based rate (swap + spread); actual funding cost depends on what specific instruments Treasury issued. The two can differ by tens of basis points, and that difference is the basis risk Treasury holds.
- Forgetting that CIP fails post-2008. A question that asks for the forward rate using is asking the textbook formula. In practice, the cross-currency basis means the actual forward rate is offset from this by 20-100 bps depending on currency and tenor.
Bottom line
- Funds transfer pricing (FTP) charges business lines the cost of funding they consume and credits funding they provide, isolating duration and liquidity risk in Treasury where it can be managed.
- FTP methods: zero cost (worst, distorts pricing and drove pre-2008 fragility), average cost (blends old and new), and matched-maturity marginal cost (FSB best practice, uses the swap curve at trade tenor).
- Contingent liquidity risk charge equals committed line size times stress drawdown rate times HQLA opportunity cost, capturing the cost of undrawn conduit-style commitments since 2008.
- FX swaps exchange spot and reverse at a forward; cross-currency swaps also exchange interest. CIP sets the textbook forward at ; deviations are the cross-currency basis.
Exam shortcut
When a question contrasts FTP methods, the right answer is matched-maturity marginal cost using the bank's funding curve at trade tenor. When it asks about cross-currency basis, the right driver is regulatory balance-sheet constraints, not transaction costs. When it asks for ALM gap impact, match the horizon: repricing for short, duration for long.
The full lesson (about 3,825 words, 26 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
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