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

§         Methods for calculating FTP

§         Using FTP in an MCIF

Every now and then it’s good to get back to the basics.  Remember the “4 P’s” of marketing?  They are: Product, Price, Place and Promotion.  When pricing bank products, if you charge too little for your loans or pay too much for your deposits then you will end up with less net interest income – in other words less Profit – and profit is actually the fifth and most important “P” of marketing.

A bank’s total net interest income is the difference between its interest income (generated from loans) and interest expense (paid on deposits).  What’s essential to know is that the net interest income is by far the largest driver of product profitability, typically accounting for up to 80% of a bank’s revenue.

Your income statement is designed to calculate net interest income for your entire bank.  It is not designed to calculate the net interest income of your products.  In order to calculate net interest income for your products, your bank needs to take value away from its loans by using a “funding rate” – and add value to its deposits by using an “earnings rate.”  This process is called Funds Transfer Pricing (or FTP).

Methods for calculating FTP

Single Pool FTP.  By using single pool FTP, the funding rate is the same rate as the earnings rate.  This rate could be your investment portfolio yield.  However, single pool FTP doesn’t take into consideration the maturity of your products.  For instance, the FTP on a 30-year mortgage would be the same as the FTP on a 3-month CD even though a 30-year mortgage may be more risky to your bank (from an asset/liability management perspective).

Multiple Pool FTP.  By using multiple pool FTP, each portfolio of products is given an FTP rate based on its maturity.  The funding rates for loans and earnings rates for deposits are based on a yield curve.

Short-term loans (e.g., credit cards or lines of credit) usually have higher interest rates than long-term loans (e.g., mortgage loans) – resulting in higher net interest income.  Unlike a mortgage loan that is secured by your house, these short-term loans are not typically secured with collateral and therefore are more risky loans for the bank to make.  Because they have more risk, the bank typically charges more interest for these short-term loans.

On the other hand, short-term deposits (e.g., checking or savings) usually have lower interest rates than long-term deposits (e.g., 5-year CDs) – resulting in higher net interest income.  Unlike a CD that requires a penalty when withdrawn before its maturity date, these short-term deposits can be very volatile because they can be withdrawn at any time without a penalty.  Therefore, a bank typically pays lower interest for these short-term deposits than they pay for more stable long-term deposits.

Historical FTP.  This is the most comprehensive method available for calculating net interest income because it is applied at the account level (term loans and deposits) as of the date of origination.  Banks that utilize Historical FTP have a very powerful tool for pricing their products as well as managing their operations more efficiently.

There are a number of benefits for having Historical FTP data reside in your MCIF.  CFOs typically use Historical FTP rates to make weekly or monthly product pricing decisions.  As a marketer, you can also identify which of your CD and IRA customers are rate sensitive – which could provide enormous savings to your bank!

Senior Management can also use the Historical FTP that resides in your MCIF to reward branch managers and loan officers who set pricing based on Historical FTP as a benchmark.  For example, a loan officer could be held accountable for pricing an auto loan at not less than 2.00% above the most recent Historical FTP funding rate.

Using FTP in an MCIF

Regardless of the method — whether it’s single pool, multiple pool, or Historical FTP, by properly using FTP within your MCIF, you will be able to understand the profitability of your products based on their pricing, balance, and even maturity attributes as well as the profitability of your customers based on their product use.  In effect, having FTP data in your MCIF transforms it into a sophisticated asset/liability tool.  Using FTP for your bank’s pricing could also transform your Marketing Department from a cost center to a profit center.  When it comes to the basics, FTP is powerful stuff!

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