FTP can be understood as a mechanism for distributing revenue between profit centres, which can contribute to better financial performance evaluation of these business units.
The Organisation for Economic Co-operation and Development (OECD) recommends that each financial institution should have its FTP policy governing the basis on which funds are transferred between different business units and treasury.
[5] In financial institutions adopting FTP, the treasury is responsible for liquidity management and the internal pricing of funds to its different business units.
[6] FTP is a specific type of transfer pricing and is identified by the Organisation for Economic Co-operation and Development (OECD) as a treasury dealing.
[5] FTP measures the value of funds transferred through the treasury between business units within a financial institution.
[4] Considering a centralised organisation, internal trade is mandated and the fund transfer price unilaterally determined by the treasury.
As expected, given the centralized decision making, the transfer price does not affect profit itself, only how it is split among the business units.
[5] The way financial institutions manage and assess performance internally is closely intertwined with choices made in terms of operational structures.
[6][10] The extensive list of regulators that discuss the implementation of FTP in financial institutions included the Basel Committee on Banking Supervision (BCBS), European Parliament and the European Commission (EC), the Committee for European Banking Supervisors (CEBS), the Institute for International Finance (IIF), the Counterparty Risk Management Policy Group III (CRMPGIII), the US Federal Reserve, and the US Federal Deposit Insurance Corporation.
If a bank can obtain 3-year borrowing at 3% but is only paying 2% on their 3-year customer deposits (CDs) then each CD is providing 1% of the value each of the 3 years it is open.
Note that this is additionally an important audit concern and of taxation interest as transfer pricing affects where and in which business unit profit is reported.
[16] The calculation is additionally complicated by contract- or customer-specific factors: (i) the length of time an asset or liability is repaid may not be clearly contracted or specified; (ii) the extent to which an asset has been or can be securitised affects its liquidity; (iii) the behaviour of customers in particular product/customer niches such as customers' propensity to withdraw long-term deposits at a penalty, or to repay obligations such as mortgages early.
The implementation of FTP gives way for management accountants to play a more significant role within the financial service industry under a performance evaluation focus.
[18][19][17][10] Performance measures are potentially incomplete,[20] and FTP can provide incremental information in the managerial decision process.
[23] On a practical approach, FTP may be set using an interest rate curve based on the marginal funding costs faced by the financial institution.