There are 4 key business rules to accurately quantify profitability and make effective pricing decisions.
- Funds Transfer Pricing (FTP)
- Provision Allocation
- Expense Allocation
- Capital Allocation
Funds Transfer Pricing (FTP)
Funds Transfer Pricing (FTP) is used to calculate cost of funds (on loans) and value of funds (on deposits). FTP uses a funding curve from a non-proprietary source (for example: FHLB, LIBOR). Funding curve is used as a proxy for the institution's marginal cost of funds at any given maturity point.FTP assumes marginal funding (eliminates timing risk) and match funding (eliminates interest rate risk).
FTP options include:
- Single/Multiple Pools
- Match Funded FTP
Provision Allocation
Allocate provision expense based on risk for both annual and maximum life allocation. Annual or lifetime loan loss reserve charges are applied by risk rating, which allows reserve charges to be recognized over time, rather than front-loaded at the time a loan is booked.
Lifetime (max) loss sets a ceiling on total credit expense recognized over life of a loan. Max loos is 7 years of provision expense..
Options include:
- Risk Rating
- Risk Rating + Product
- Consumer Credit Score
Expense Allocation
Expense allocation is a process to allocate out expenses to products based on cost/effort to support the product (for example: personnel, occupancy, operational and other expenses). Expense allocation provides the ability to have origination and normal servicing costs for each product plus may also tier based on loan size.
The amount of expense for each customer account will vary based on the type of account and the transactions associated with the account. Expenses are allocated by $ tiers for commercial loans with origination expense amortized over the loan term and servicing/overhead expense being monthly.
Options include:
- Product Cost
- Transactional Costs
Capital Allocation
Allocate capital to products based on capital requirements of each product. Can also include an additional capital provision based on risk of loan.
Capital risks originate from both sides of the balance sheet (for example: credit risk, market risk, liquidity risk, operational risk).
Capital allocation rates:
- Loan Products – Rates based on Risk Weighted Asset calculations
- Checking Products – 2.50%
- Savings/CD Products – 1.25%
Capital is allocated to unfunded commitments (for example: operating lines, construction lines).
- Unfunded Short Term – 20% of capital rate
- Unfunded Long Term – 50% of capital rate
Capital adjustment allocated based on the loan’s risk rating:
| Rank Name | Limits | Rank |
|---|---|---|
| 5 Star | 49.00% or higher |  |
| 4 Star | 14.00% - 48.99% |  |
| 3 Star | 00.00 - 13.99% |  |
| 2 Star | -48.99% - 00.01% |  |
| 1 Star | -49.00% or lower |  |
Note: If fee income represents more than 30% of the profit an * is assigned to the rank. 