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

Pricing Assets, Liabilities and Contingent Liquidity Risk in LTP

Updated 11 October 2026 · Fact-checked

Liquidity transfer pricing (LTP) charges each asset, credits each liability and prices each off-balance-sheet commitment for the liquidity it uses or provides. You match the product's expected (behavioral) cash-flow life to a funding curve, add a contingent charge for undrawn lines, and allocate the cost of the liquidity buffer to the units that cause it.

Understand Pricing Assets, Liabilities and Contingent Liquidity Risk

Liquidity transfer pricing moves funding cost from business units to a central treasury. A lending desk does not fund itself. Treasury charges it a funding rate for each loan. A deposit desk does not just take in cash. Treasury pays it a credit for the stable funding it brings in. The aim is that each unit sees the true liquidity cost or value of what it does.

The key idea is matching. A 5-year fixed loan needs funding for about 5 years, so it is charged a rate from the 5-year point of the funding curve, not the overnight rate. The charge follows the behavioral maturity, not always the contractual one. A mortgage with prepayments has a shorter expected life than its contract. A core deposit that can legally leave tomorrow may in practice stay for years. Its credit is based on the stable portion and its observed behavior, and that portion gets a longer-tenor rate.

Off-balance-sheet items such as undrawn credit lines create contingent liquidity risk. The bank has promised cash on demand, usually in stress, when customers draw most. The bank must hold liquid assets against this possibility, and that costs money. So the commitment is charged a contingent liquidity charge. It is based on the expected drawdown under stress, the cost of holding liquid assets against it, and often the undrawn amount. The charge is paid by the unit that wrote the commitment, even though no cash has left yet.

The liquidity buffer is a stock of high-quality liquid assets. It earns less than the bank pays to fund it, so it has a negative carry. That cost is a real cost of doing business and must be allocated. Good practice allocates it to units in proportion to the stress outflows or contingent exposures they generate, not evenly across the bank. Units that create stress risk pay more. Units that bring stable funding pay less.

When the exam asks about better practice, look for three tests: charges and credits reflect the real liquidity behavior, they are applied to every product including commitments, and costs are passed to the units that cause them. Pricing that ignores any of these gives wrong incentives, such as growth in cheap-looking but liquidity-hungry lines.

Key formulas to remember

Funding charge on an asset: Charge = Balance × transfer rate at behavioral tenor; Use expected life after prepayment, not contractual maturity.
Funding credit on a liability: Credit = Stable balance × transfer rate at behavioral tenor + volatile balance × short-tenor rate; Split core and non-core deposits before assigning tenors.
Transfer rate build-up: Transfer rate = base funding curve rate + term liquidity premium; Premium should reflect the bank's own cost of term funding.
Contingent liquidity charge: Charge = Undrawn amount × stress drawdown % × buffer cost rate; Buffer cost rate = yield on funding minus yield on liquid assets.
Buffer carry cost: Buffer cost = Buffer size × (funding cost − liquid asset yield); This is the amount allocated to business units.
Buffer allocation: Unit share = unit stress outflow ÷ total stress outflow; Allocate by contribution to liquidity risk, not by size alone.

How to solve Pricing Assets, Liabilities and Contingent Liquidity Risk questions

Use the same sequence for any LTP pricing question on assets, liabilities or commitments.

1Identify the product: asset, liability or off-balance-sheet commitment.
2Find the behavioral maturity. Adjust for prepayments, rollovers and the stable share of deposits.
3Pick the matching point on the funding curve and read the transfer rate, including any term liquidity premium.
4Charge assets and credit liabilities at that rate on the relevant balance.
5For commitments, compute the stress drawdown amount and apply the buffer cost rate.
6Compute the buffer's net carry cost and allocate it by each unit's contribution to stress outflows.
7Check the incentive. Ask whether the result makes units pay for liquidity risk they create and rewards stable funding.
8State the answer with units and sign: charge is a cost to the unit, credit is a benefit.

Quickest way: Charge, credit, contingent: three-line check

When to use it: Use when a multiple-choice question gives rates and balances and offers four numerical or conceptual answers.

Decide the tenor first. Behavioral beats contractual.
Multiply balance by the rate at that tenor. Asset is a cost, liability is a credit.
For lines, multiply undrawn × stress drawdown % × (funding rate − liquid asset yield).
For concept questions, eliminate options that use flat or overnight rates, ignore commitments, or spread buffer cost evenly without a link to risk.

Common mistakes in Pricing Assets, Liabilities and Contingent Liquidity Risk

Using contractual maturity for the transfer rate.
It is the figure printed on the contract.
Fix: Use expected life after prepayments, and the stable share and observed behavior for deposits.
Treating all deposits as overnight funding.
Demand deposits can legally be withdrawn at once.
Fix: Split into core and volatile parts. Credit the core part at a longer tenor.
Charging nothing for undrawn credit lines.
No cash moves and nothing appears as funding on the balance sheet.
Fix: Apply a contingent charge on the expected stress drawdown, since the bank must hold liquid assets against it.
Applying the drawdown rate to the drawn balance instead of the undrawn amount.
The drawn balance is already funded and charged as an asset.
Fix: Apply the stress drawdown percentage to the undrawn limit only.
Allocating buffer cost equally or by balance sheet size.
It is simple and looks fair.
Fix: Allocate by contribution to stress outflows so risk-creating units bear the cost.
Using the buffer's total size as its cost.
Confusing size with carry.
Fix: Cost is size × (funding cost − liquid asset yield).

Worked examples

Example 1

A bank has an undrawn credit line of USD 200 million. Under stress, 30% is expected to be drawn. The bank funds at 5.0% and liquid assets yield 3.5%. What is the annual contingent liquidity charge?

Show the solution

Stress drawdown = 200 × 30% = USD 60 million.
Buffer cost rate = 5.0% − 3.5% = 1.5%.
Charge = 60 million × 1.5% = USD 0.9 million.

Answer: USD 0.9 million per year, charged to the unit that wrote the line.

Example 2

A liquidity buffer of USD 1,000 million costs the bank 4.8% to fund and yields 3.3%. Stress outflows are USD 400 million for Corporate, USD 100 million for Retail and USD 100 million for Treasury. How much buffer cost is allocated to Corporate?

Show the solution

Net carry rate = 4.8% − 3.3% = 1.5%.
Total buffer cost = 1,000 × 1.5% = USD 15 million.
Total stress outflow = 400 + 100 + 100 = USD 600 million.
Corporate share = 400 ÷ 600 = 2/3.
Corporate cost = 15 × 2/3 = USD 10 million.

Answer: USD 10 million is allocated to Corporate.

Exam tips

Expect a concept question asking which pricing feature is better practice. Pick the option with behavioral maturity, contingent charges and risk-based allocation.
Check whether a question wants the charge on the undrawn amount or the drawn balance. Read the wording twice.
The buffer cost uses the spread between funding cost and liquid asset yield, not the full funding rate.
On phones, write the one line formula before calculating. It stops slips with percentages.

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

Pricing Assets, Liabilities and Contingent Liquidity Risk in other exams

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

Pricing Assets, Liabilities and Contingent Liquidity Risk: frequently asked questions

What is behavioral maturity in transfer pricing?

It is the expected life of a product based on real customer behavior, not the contract. Prepayments shorten loan life, and stable core deposits lengthen deposit life. The transfer rate is read at this tenor.

Why price undrawn credit lines?

The bank must provide cash on demand, often in stress when drawdowns rise. It holds liquid assets against this, which costs money. The charge passes that cost to the unit writing the commitment.

How should liquidity buffer costs be allocated?

Allocate the net carry cost of the buffer to units according to how much stress outflow or contingent exposure each creates. Equal or size-only splits weaken incentives.

Do deposit units get a credit in LTP?

Yes. They are credited for stable funding at a rate matching its behavioral tenor. Volatile balances earn a shorter-tenor, lower credit.