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OCC BULLETIN 2016-7
To: Chief Executive Officers of All National Banks and Federal Savings Associations, Department and Division Heads, All Examining Personnel, and Other Interested Parties

Description: Interagency Guidance

Summary

The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (collectively, the agencies) are jointly issuing the “Interagency Guidance on Funds Transfer Pricing Related to Funding and Contingent Liquidity Risks.” This interagency guidance addresses funding risk and contingent liquidity risk for national banks and federal savings associations with consolidated assets of $250 billion or more (collectively, firms).

Note for Community Banks

This interagency guidance does not apply to community banks.

Highlights

This interagency guidance explains that firms should

  • allocate funds transfer pricing (FTP) costs and benefits on funding risk and contingent liquidity risk.
  • have a consistent and transparent FTP framework for identifying and allocating FTP costs and benefits on a timely basis and at a sufficiently granular level, commensurate with the firm’s size, complexity, business activities, and overall risk profile.
  • have a robust FTP governance structure including the production of a report on FTP and providing oversight from a senior management group and central management function.
  • align business incentives with risk management and strategic objectives by incorporating FTP costs and benefits into product pricing, business metrics, and new product approval.

Background

FTP is an important process for managing a firm’s balance-sheet structure and measuring risk-adjusted profitability. By allocating funding and contingent liquidity risks to business lines, products, and activities within a firm, FTP influences the volume and terms of new business and ongoing portfolio composition. This process helps align a firm’s funding and contingent liquidity risk profile and risk appetite. This process complements, but does not replace, broader liquidity and interest rate risk management programs (for example, stress testing) that a firm uses to capture certain risks. If done effectively, FTP promotes more resilient, sustainable business models. FTP is also an important tool for centralizing the management of funding and contingent liquidity risks for all exposures. Through FTP, a firm can transfer these risks to a central management function that can take advantage of natural offsets, centralized hedging activities, and a broader view of the firm.

Failure to consistently and effectively apply FTP can misalign the risk-taking incentives of individual business lines with the firm’s risk appetite, resulting in a misallocation of financial resources. This misallocation can arise in new business and ongoing portfolio composition where the business metrics do not reflect risks taken, thereby undermining the business model. Examples include entering into excessive off-balance-sheet commitments and on-balance-sheet asset growth because of mispriced funding and contingent liquidity risks.

The 2008 financial crisis exposed weak risk management practices for allocating liquidity costs and benefits across business lines. Several firms “acknowledged that if robust FTP practices had been in place earlier, and if the systems had charged not just for funding but for liquidity risks, they would not have carried the significant levels of illiquid assets and the significant risks that were held off-balance sheet that ultimately led to sizable losses.”1

Further Information

Please contact Christopher McBride, Credit and Market Risk Division, at (202) 649-6416.

 

Jennifer C. Kelly
Senior Deputy Comptroller and Chief National Bank Examiner

Related Link


1Senior Supervisors Group report on “Risk Management Lessons From the Global Financial Crisis of 2008” (October 21, 2009) is available at https://www.newyorkfed.org/medialibrary/media/newsevents/news/banking/2009/SSG_report.pdf.