FRM Exam Part II · Liquidity Transfer Pricing: A Guide to Better Practice

Building the Funds Transfer Pricing Curve and Methods

Updated 11 October 2026 · Fact-checked

A transfer pricing curve is the internal rate schedule by maturity that a bank's treasury charges business units for funds used and pays them for funds raised. You build it from the bank's own marginal funding cost: a risk-free base rate plus a term liquidity premium. Then you apply it through pooled or matched-maturity methods.

Understand Building the Transfer Pricing Curve and Methodologies

Every bank business unit either uses funds (loans) or supplies funds (deposits). Liquidity transfer pricing (LTP, often called funds transfer pricing or FTP) puts a price on those funds, so that each unit sees the true cost and benefit of liquidity. Treasury acts as the internal bank. It charges lenders and pays depositors using one internal curve.

The curve is built by maturity. Start with a base curve, usually a risk-free or swap curve (for example SOFR or EUR swaps). Then add the bank's liquidity premium for each tenor. That premium is the extra cost the bank pays to raise funds of that term in the market, over the base rate. It comes from the bank's own term funding: unsecured bond issuance, term deposits, and secured funding such as repo or covered bonds.

Two parts of the spread need care. The credit spread reflects the bank's own default risk. The term premium or term liquidity premium reflects the cost of locking in funds for longer. Good practice uses the marginal (current) cost of funds, not the historical average, because new business is funded at today's prices. Secured funding is cheaper than unsecured. The curve should reflect the funding the bank would really need to raise for the asset, and the bank's contingent liquidity needs should be priced separately.

Methods differ in how the curve is applied. In matched-maturity FTP, each loan or deposit is priced at the curve point equal to its expected cash-flow life, and the rate is locked in for the life of the deal. This removes liquidity and interest rate risk from the business unit and shifts it to treasury. In pooled FTP, all funds are put in a pool and a single average rate is charged and paid. This is simple but ignores maturity and gives wrong incentives. Hybrids use a few buckets or pools by tenor. Behavioural maturity is used for products like non-maturity deposits and revolving credit lines.

Key formulas to remember

FTP rate for a tenor: FTP(t) = Base rate(t) + Liquidity premium(t); Base rate is risk-free or swap; premium reflects the bank's marginal term funding cost over base.
Liquidity premium: Liquidity premium(t) = Bank marginal funding yield(t) − Base rate(t); Includes the bank's credit spread and term premium. Use current, marginal cost.
Business unit net interest margin (matched): Margin = Customer rate − FTP(behavioural maturity); For a deposit, the credit is FTP(t) − Deposit rate.
Pooled rate: Pool rate = Total funding cost ÷ Total funds in pool; One average rate for all maturities; ignores tenor.
Weighted average FTP for multi-tranche funding: Σ(wᵢ × rateᵢ), where wᵢ = share of tranche i; Used for blending secured and unsecured funding costs.

How to solve Building the Transfer Pricing Curve and Methodologies questions

Use this order for most FTP curve and method questions in the exam.

1Identify what is asked: curve construction, method choice, or the margin of a unit.
2Find the base rate for the right tenor. Use behavioural maturity, not contractual, if the product has non-maturity features.
3Identify the bank's marginal funding cost for that tenor and whether it is secured or unsecured.
4Compute the liquidity premium as funding yield minus base rate, then FTP = base + premium.
5For margins, subtract FTP from the customer rate for assets, or FTP from the deposit rate for liabilities (credit = FTP − deposit rate).
6Compare methods: matched-maturity gives correct incentives and locks the rate; pooled is simple but misprices tenor.
7State the interpretation: who bears the liquidity risk and what behaviour the price encourages.

Quickest way: Base plus premium, then match the tenor

When to use it: Numerical questions with a given base curve and funding spreads, or conceptual questions that ask which method fits.

Write the tenor and read the base rate.
Add the marginal liquidity premium for that tenor.
Subtract from customer rate (assets) or from FTP (deposits).
For method questions: if the answer needs correct incentives by tenor, pick matched-maturity; if it stresses simplicity, pick pooled.

Common mistakes in Building the Transfer Pricing Curve and Methodologies

Using the bank's average historical funding cost as the curve.
Averages are easy to get from the accounts.
Fix: Use marginal, current cost of raising new funds at each tenor.
Using the risk-free curve alone with no liquidity premium.
Students treat FTP as an interest rate exercise only.
Fix: Always add the bank's liquidity premium, which includes credit spread and term premium.
Pricing a non-maturity deposit at overnight rate.
Contractual maturity is overnight.
Fix: Use behavioural maturity for the stable portion, so the deposit gets a longer, higher FTP credit.
Saying pooled FTP is best because it is simple.
Simplicity sounds attractive.
Fix: Pooled pricing ignores tenor, so long assets look too profitable and short ones too costly; it encourages mismatches.
Applying one unsecured spread to all assets.
Ignoring that secured funding is cheaper.
Fix: Reflect the funding the asset could support, such as secured funding for liquid collateral, and price contingent liquidity separately.
Reversing the sign for deposits.
Deposits are a source, not a use, of funds.
Fix: For deposits, the unit earns FTP minus the rate paid to the customer.

Worked examples

Example 1

The 5-year USD swap rate is 4.00%. The bank can issue 5-year unsecured bonds at a yield of 5.30%. It lends a 5-year bullet loan at 6.10%. Using matched-maturity FTP, what is the loan's margin for the business unit?

Show the solution

Liquidity premium = 5.30% − 4.00% = 1.30%.
FTP = 4.00% + 1.30% = 5.30%.
Margin = 6.10% − 5.30% = 0.80%.

Answer: FTP is 5.30%; the unit's margin is 0.80%, locked for the life of the loan.

Example 2

A bank's pool has ₹800 crore of 1-year funding at 6.0% and ₹200 crore of 5-year funding at 8.0%. A unit makes a 1-year loan at 7.0%. Compare the margin under pooled FTP with the margin under matched-maturity FTP, where the 1-year FTP is 6.0%.

Show the solution

Pooled rate = (800 × 6.0% + 200 × 8.0%) ÷ 1,000 = (48 + 16) ÷ 1,000 = 6.4%.
Pooled margin = 7.0% − 6.4% = 0.6%.
Matched margin = 7.0% − 6.0% = 1.0%.
Difference: pooling charges the short loan for the cost of long funding it does not use.

Answer: Pooled margin is 0.6%; matched-maturity margin is 1.0%. Pooling understates the short loan's profit.

Exam tips

Questions often ask which method gives correct incentives. Matched-maturity is the usual best-practice answer.
Remember that the curve uses marginal cost, and name the credit spread and term premium as components.
For non-maturity deposits, look for behavioural maturity in the options.
Check the sign convention for assets versus liabilities before choosing an option.

Practice questions from Liquidity Transfer Pricing: A Guide to Better Practice

Building the Transfer Pricing Curve and Methodologies in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Building the Transfer Pricing Curve and Methodologies: frequently asked questions

What is the difference between pooled and matched-maturity FTP?

Pooled FTP charges and credits one average rate to all units regardless of tenor. Matched-maturity FTP uses the curve rate for each deal's maturity and locks it. Matched-maturity removes liquidity and rate risk from the business unit and gives better incentives.

What is in the liquidity premium curve?

It is the bank's marginal funding yield minus the base rate at each tenor. It contains the bank's own credit spread and a term premium. It can be built from unsecured and secured funding costs.

Why use marginal rather than average funding cost?

New loans are funded at today's prices. Average cost hides current market conditions and can lead to underpriced lending when funding costs rise.

How are non-maturity deposits priced in FTP?

They are priced on behavioural maturity, based on how long the stable balance is expected to stay. The unit then receives the FTP rate for that tenor less the rate paid to customers.