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

A bank charges lending desks only a short-term funding rate for long-dated loans, while the treasury bears the cost of rolling the funding. Which is the MOST likely consequence for incentives?

Lending desks will under-price and over-originate long-term loans, leaving treasury with a funding mismatch and rollover risk. Charging only a short-term rate omits the term liquidity premium, so the desks' reported profitability is overstated and the incentive points toward excessive long-dated asset growth.

  1. ALending desks will under-price long-term loans and grow them excessively, leaving treasury with a funding mismatchCorrect
  2. BLending desks will reduce long-term lending because charges are too high
  3. CDeposit-gathering units will be overcredited for stable funding
  4. DTreasury will earn no net interest margin from the mismatch

Explanation

If the charge ignores the loan's tenor, the term liquidity premium is not passed on, so long-term loans appear more profitable than they are. Desks are incentivised to expand them, and treasury is left with rollover and funding risk. Overcharging is the opposite of what occurs.

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