The transfer curve, the asset and funding margins and the treasury residual, worked line by line on one illustrative bank, with the deposit-life assumption that decides the split.
Funds transfer pricing charges every asset, and credits every liability, an internal rate from one curve set at the duration of that balance, so that each business keeps only the spread it creates and treasury keeps the mismatch. On an illustrative bank earning 211,535 of net interest income, the funding side, almost all of it deposits, earns 135,811, 64.2 per cent of the margin, the lending and securities side 64,984 and treasury 10,740. Change the assumed life of the deposits from 4.2 to 2 years and the funding share falls to 51.2 per cent, with no change in the bank's total.
Worked in full in Bank Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Net interest income is one number earned by two activities: collecting funds and lending them. Without a transfer price, the lender of a fixed-rate loan funded by overnight deposits is credited with the whole spread, including the reward for a rate bet nobody asked it to take, and the branch that gathered the deposits is credited with nothing. Funds transfer pricing (FTP) separates the three sources: the credit spread on the asset, the franchise spread on the funding, and the maturity mismatch between them, which belongs to the treasury that manages it.
The case is Sagebrook National Bank, the fictional bank of Bank Management, in year 0 before the rate shock. Amounts in thousands of dollars.
| Input | Value |
|---|---|
| Transfer rate at zero duration (the market rate) | 1.55% |
| Slope, per year of duration | 0.25% |
| Curve flat beyond, years | 5 |
| Interest income / interest expense | 246,192 / 34,657 |
| Assumed life of non-maturity deposits, years | 4.2 |
FTP rate = 1.55% + 0.25% × min(duration, 5)
Asset margin = balance × (yield − FTP rate)
Liability margin = balance × (FTP rate − cost)
Treasury = net interest income − asset margins − liability margins
Excel: =Bal*(Yield-(Mkt+Slope*MIN(Dur,5)))
Step 1: the asset side. A fixed-rate loan of 3.9 years' duration is charged 1.55 + 0.25 × 3.9 = 2.525 per cent. It yields 4.35, so it keeps 1.825 points, 52,012 on 2,850,000. The floating loans reprice with the market, so they are charged the overnight 1.55 and keep their 2.40 point spread, 38,640.
| Asset | Balance | Yield | Duration | FTP rate | Margin |
|---|---|---|---|---|---|
| Cash | 420,000 | 1.55% | 0 | 1.55% | 0 |
| AFS securities | 1,180,000 | 1.72% | 4.6 | 2.70% | −11,564 |
| HTM securities | 1,640,000 | 1.94% | 7.8 | 2.80% | −14,104 |
| Fixed-rate loans | 2,850,000 | 4.35% | 3.9 | 2.53% | 52,012 |
| Floating-rate loans | 1,610,000 | 3.95% | 0 | 1.55% | 38,640 |
| Asset side | 64,984 |
The securities lose money against the curve: they yield less than term funding of the same duration costs. Bought when rates were low, they were a bet on rates staying low, and FTP makes the bet visible at once. Against a single overnight rate the held-to-maturity book would have shown a profit of 6,396.
Step 2: the funding side. Non-maturity deposits are credited at their assumed life of 4.2 years, 2.60 per cent, because the bank can lend them for that long.
| Funding | Balance | Cost | Duration | FTP rate | Margin |
|---|---|---|---|---|---|
| Non-interest-bearing deposits | 1,760,000 | 0.00% | 4.2 | 2.60% | 45,760 |
| Savings deposits | 3,240,000 | 0.18% | 4.2 | 2.60% | 78,408 |
| Time deposits | 1,480,000 | 0.85% | 0.9 | 1.78% | 13,690 |
| FHLB advances | 620,000 | 1.35% | 0.25 | 1.61% | 1,628 |
| Subordinated debt | 150,000 | 5.25% | 5 | 2.80% | −3,675 |
| Funding side | 135,811 |
Step 3: treasury. The curve charges 181,208 to the assets and credits 170,468 to the funding. The difference, 10,740, is what treasury keeps, and the three pieces add back to 211,535 exactly.
Of 211,535, the funding side earns 135,811 (64.2 per cent), its deposits net of 1,628 earned on the advances and 3,675 lost on the subordinated debt,, the asset side 64,984 (30.7 per cent) and treasury 10,740 (5.1 per cent). The core deposits alone, non-interest-bearing and savings, earn 124,168, 58.7 per cent of the bank's margin. Measured with a single overnight transfer rate instead, the funding side would show 77,718, 36.7 per cent: a flat curve hands the deposit franchise's value to whoever books the long assets.
FTP is a split, not a profit. Charge 80 per cent of the 148,000 of operating expenses to deposit gathering and the funding side's 135,811 becomes 17,411. The fully loaded cost of a deposit dollar, interest plus that share of expenses, is 2.11 per cent in year 0 and 3.68 after the 425 basis point shock, which is where the year's pressure on the margin comes from.
| Deposit life, years | FTP credit | Funding margin | Share of NII | Treasury | Funding after expenses |
|---|---|---|---|---|---|
| 1 | 1.80% | 95,810 | 45.3% | 50,740 | −22,590 |
| 2 | 2.05% | 108,310 | 51.2% | 38,240 | −10,090 |
| 3 | 2.30% | 120,810 | 57.1% | 25,740 | 2,410 |
| 4.2 | 2.60% | 135,811 | 64.2% | 10,740 | 17,411 |
| 5 | 2.80% | 145,810 | 68.9% | 740 | 27,410 |
The bank's total never moves. What moves is who is told they earned it. On a two-year assumption the branches lose money after expenses and treasury looks like a profit centre; on five years treasury earns almost nothing. The deposit life is an assumption nobody can observe, the same one that drives the deposit franchise in EVE sensitivity, so it should be set once, documented and used for both.
The common mistake is a single-rate FTP: every balance charged or credited at the overnight rate. It makes long fixed-rate assets look profitable in a low-rate year and leaves the rate risk with nobody, which is how a bank ends up with securities that lose money against their own funding the moment rates rise. The second is to credit non-maturity deposits at their contractual maturity of zero, which pays them only the overnight rate and hands their term value to treasury. The margin, the deposit beta and the transfer pricing are live in the free workbooks for Sagebrook; the year-on-year margin itself is in how to calculate net interest margin.
The curve rate at the deposit's assumed behavioural life, not its contractual maturity of zero. On the illustrative curve of 1.55 per cent plus 0.25 per cent per year, a 4.2-year assumed life gives 2.60 per cent, so savings deposits costing 0.18 per cent earn 2.42 points, 78,408 on 3,240,000. At a one-year life the credit would be 1.80 per cent.
Because they yield less than term funding of the same duration costs. Held-to-maturity securities yielding 1.94 per cent with a 7.8-year duration are charged 2.80 per cent, the curve's flat rate beyond five years, and lose 0.86 points, 14,104 on 1,640,000. Against the 1.55 per cent overnight rate they would have shown a profit of 6,396, hiding the rate bet.
The difference between the transfer rates it charges the assets and credits the funding, which is the bank's maturity mismatch and the benefit of funding part of the assets with equity. On the illustrative bank it charges 181,208 and credits 170,468, keeping 10,740 of the 211,535 margin. With a five-year deposit life it would keep only 740.
This article is one calculation from Bank Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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