Board of Governors of the Federal Reserve System

The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency are issuing the attached guidance to address weaknesses observed in large financial institutions’ funds transfer pricing (FTP) practices related to funding risk (including interest rate and liquidity components) and contingent liquidity risk.¹  The guidance builds on the principles of sound liquidity risk management described in SR letter 10-6, “Interagency Policy Statement on Funding and Liquidity Risk Management,”² and incorporates elements of the international statement issued by the Basel Committee on Banking Supervision titled “Principles for Sound Liquidity Risk Management and Supervision.”³

FTP is an important tool for managing a firm’s balance sheet structure and measuring risk-adjusted profitability.  By allocating funding and contingent liquidity risks to business lines, products, and activities within a firm, FTP influences the volume and terms of new business and ongoing portfolio composition.  If done effectively, FTP promotes more resilient, sustainable business models.  Conversely, failure to consistently and effectively apply FTP can misalign the risk-taking incentives of individual business lines with the firm’s risk appetite, resulting in a misallocation of financial resources.  This misallocation can arise in new business and ongoing portfolio composition where the business metrics do not reflect risks taken, thereby undermining the business model.  Examples include entering into excessive off-balance sheet commitments and on-balance sheet asset growth because of mispriced funding and contingent liquidity risks.

FTP is also an important tool for centralizing the management of funding and contingent liquidity risks for all exposures.  Through FTP, a firm can transfer these risks to a central management function that can take advantage of natural offsets, centralized hedging activities, and a broader view of the firm.

A firm should use the principles laid out in the guidance to develop, implement, and maintain an effective FTP framework.  In doing so, a firm’s risk-taking incentives should better align with its risk management and strategic objectives.  The framework should be adequately tailored to a firm’s size, complexity, business activities, and overall risk profile.

Reserve Banks are asked to distribute this letter to financial institutions in their district that are domestic bank and savings and loan holding companies and state member banks with consolidated assets of $250 billion or more or foreign exposure of $10 billion or more, and foreign banking organizations with combined U.S. assets of $250 billion or more and to appropriate supervisory staff.  Questions regarding this letter should be directed to staff in the Risk Policy section:  Adam Trost, Senior Supervisory Financial Analyst, at (202) 452-3814.  In addition, questions may be sent via the Board’s public website.⁴

Notes: