FUND TRANSFER PRICING

Managing Pricing and Profitability for Banks

A report submitted by Vinit Mehta

Mumbai Educational Trust Bhujbal Knowledge Cetre,

Bandra Reclamation, Bandra (West),

Mumbai 400050.

A Project report on

“FUND TRANSFER PRICING -Managing Pricing and Profitability for Banks”

Submitted by:

Vinit Mehta

METIOM MMS (Finance)

Roll No 90

Batch 2012-2014

Submitted on 5th August, 2013

A Report submitted to the University/Institute in partial fulfillment of the requirement of MMS for the year 2013.

Under the guidance of

Mr. Arvind Girotra (Senior Manager-Business Advisory Services, Ernst & Young) &

Mr. Amit Jha ( Senior Consultant-Business Advisory Services, Ernst & Young)

ACKNOWLEDGEMENT

My experience at Ernst & Young would not have been as fulfilling, if not for the guidance, motivation and support of all my mentors. I am indebted to everyone who made it possible for me to understand the application of Fund Transfer Pricing, learn the ways of a corporate organization which has augmented my professional growth, over the last two months. And I wish to express my sincere gratitude to all those people.

First I would like to express my profound gratitude and deep regards to my mentor Mr Amit Jha (Senior Consultant-Business Advisory Services, Ernst & Young) for his exemplary guidance, monitoring and constant encouragement throughout the course of this project. The knowledge, help and guidance given by him time to time helped me understand this topic.

I am grateful to Mr. Arvind Girotra (Senior Manager-Business Advisory Services, Ernst & Young) and Mr. Nilesh Naker (Associate Director - Financial Services, IT Advisory, Ernst & Young) for guiding me during my internship and patiently answering my many queries.

I would like to thank Mr. Ashvin Parekh (Partner, Global Financial Leader, Ernst & Young) and Mr. Eric Anklesaria (Partner, Global Financial Leader, Ernst & Young) for giving me this opportunity to work with the organization and encouraging me throughout my project work. I also wish to thank my colleagues and friends at Ernst and Young for generously spending time with me, answering my queries and ensuring that this SIP would be an experience to cherish.

I also take this opportunity to express a deep sense of gratitude to our institute MET for cordial support, valuable information and guidance, which helped me in completing this task through various stages.

ContentsExecutive Summary...................................................................................................................1

About Ernst & Young................................................................................................................3

1 Introduction........................................................................................................................5

1.1 Traditional method for Evaluating Profitability..........................................................7

1.2 Drawbacks of traditional Method................................................................................7

1.3 Fund Transfer Pricing Method for calculating profitability........................................8

1.4 The Need for Fund Transfer Pricing...........................................................................9

1.5 Objectives of Fund Transfer Pricing...........................................................................9

2 Fund Transfer Pricing Implementation Process...............................................................10

3 Banking Products.............................................................................................................11

4 Fund Transfer Pricing Mechanism...................................................................................12

4.1 Selection of Transfer Curve.......................................................................................12

5 Fund Transfer Pricing Methodologies.............................................................................14

5.1 Pool Method..............................................................................................................14

5.1.1 Single Pool Method............................................................................................14

5.1.2 Double Pool Method..........................................................................................15

5.1.3 Advantages and Drawbacks of Pool Method.....................................................16

5.2 Multiple Pool Method................................................................................................17

5.2.1 Advantages and Drawbacks...............................................................................17

5.3 Matched Rate Method...............................................................................................18

5.3.1 Duration method.................................................................................................20

5.3.2 Weighted Average Cash Flow (WACF)............................................................21

5.3.3 Zero Coupon Pricing..........................................................................................22

5.3.4 Straight Term Method........................................................................................23

5.3.5 Redemption Curve method................................................................................24

6 Calculation Of FTP On Different Banking Products.......................................................25

6.1 Calculation of FTP on CASA....................................................................................25

6.2 Calculation of FTP for Term Deposit........................................................................28

6.3 Calculation of FTP for Loans....................................................................................30

6.3.1 Calculation of FTP for Non Amortizing Loans bearing fixed interest..............30

6.3.2 Calculation of FTP for Amortising Loans.........................................................32

7 Building Fund Transfer Pricing System...........................................................................34

8 Future Outlook and Recommendation.............................................................................35

9 Conclusion........................................................................................................................36

References................................................................................................................................38

Annexure 1...............................................................................................................................39

Abbreviations

FTP Fund Transfer Pricing

LIBOR London Interbank Offer Rate

FSI Financial Institutions

OFSAA Oracle Financial Services Analytical Applications

EY Ernst & Young

ALM Asset Liability Management

TP Transfer Price

CASA Current Account and Saving Account