By John J. Coffey, C.P.A. and Gene Palm, www.profitres.com, originally published September 2001, ABA Bank Marketing

§         How is pricing determined?

§         Sources of Historical Funds Transfer Pricing (HFTP) data for your MCIF

§         Using HFTP for pricing decisions

            Remember the “4 Ps” of marketing – product, price, placement and promotion?  In banking, a business that has been around for a while, bank products are seen by consumers as commodities.  However, these same consumers can be greatly influenced to buy (or not buy) your products based on their price, how convenient they are and how well you promote them.  Your product’s price can be more important than convenience to a consumer, so as a bank marketer, pricing is the key to selling your products.  But how is pricing determined and how can you use your MCIF to help your bank with its pricing?

How is pricing determined?

            Your bank’s net interest income (the difference between the interest income from its loans and the interest expense of its deposits) typically accounts for up to 80% of your bank’s revenue.  Therefore, your bank’s most important pricing decisions involve its loan and deposit interest rates.

            “Historical Funds Transfer Pricing” (HFTP) is the most comprehensive method available for calculating net interest income because a funds transfer pricing rate is applied at the account level for term-loans and term-deposits as of the date of origination.  (See our BankmarketingBlog entry, What is Funds Transfer Pricing, for more detailed information about HFTP.)

            For loans, the net interest income percentage (also known as “spread”) is the difference between the loan rate and the HFTP rate.  For deposits, the spread is the difference between the HFTP rate and the deposit rate.  To calculate the net interest income in dollar terms, simply multiply the spread by the loan or deposit balance.

Sources of funds transfer pricing data for your MCIF

            All this said, you still need a source of HFTP data in order to perform these calculations.  In the MCIF industry, there are currently three different options available to users who want to utilize HFTP data for their pricing decisions:

1.       Cost-accounting interface

Building an interface between a cost-accounting system and your MCIF could provide a comprehensive means for utilizing HFTP data.  Typically, if there is an HFTP module (along with the other cost-accounting modules) that calculates profit at the account level, then this account-level profit is imported directly into the MCIF and applied directly to each account.  This method is the most expensive and complex option and can take a number of years to implement.  Consequently, only a small percentage of banks in the country have accomplished the full integration of these systems.

2.       HFTP table

Using an external table of HFTP rates could provide a simplistic means for your MCIF to calculate the net interest income for your products.  While this is an inexpensive option, it may require you to purchase an additional module to perform the net interest income calculation.  Also it may not take into consideration the cash flow characteristics of various product offerings (e.g., mortgages amortize differently than auto loans) and the data might typically be consolidated at the monthly level rather than the date of origination.

3.       HFTP Service Bureau

For a number of years, MCIF users have shipped their data to demographic companies to have their household data appended with demographic data.  Now, it is possible for MCIF users to have their account data augmented with HFTP data.  This also is an affordable option and it is very useful within newer systems that allow the user to create net interest income calculations using this data.  Should you use an HFTP service bureau, your new term-loan and term-deposit accounts are typically run through a scoring routine once a quarter.  However, default funds transfer pricing rates are typically provided to calculate net interest income on term accounts that have not been scored during the interim.

Using HFTP for pricing decisions

            Once you have augmented your MCIF with HFTP data, you will be able to examine the old spread (generated by the HFTP rate and the account rate) of loans and deposits that are maturing in the next month. 

Then, you can compare this old spread with the new spread generated from the most recent HFTP data to help you determine the new interest rates for these loans and deposits.  Generating a consolidated report as well as a list of customers whose loans and deposits are maturing will help you further understand your pricing decisions.

            You can also look at recently opened term-loan and term-deposit accounts to examine how effective your pricing has been in the past, based on HFTP data.  Again, generating a consolidated report as well as list of customers who recently opened term-loan and term-deposit accounts will help you understand how to make better pricing decisions.

These two exercises can greatly help your Asset / Liability committee with its pricing decisions and can transform your Marketing department into a profit center!

John J. Coffey, C.P.A. and Gene Palm are the principals of Profit Resources, a consulting company that specializes in MCIF technologies.  © Profit Resources, Inc. 2006