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

A bank decides to apply LTP charges to the undrawn committed credit lines it provides, not only to funded loans. What is the principal rationale supported by good practice?

Contingent liquidity costs should be charged because undrawn commitments can be drawn in stress, forcing the bank to hold liquid buffers. Allocating that cost to the business originating the commitment aligns its pricing and incentives with the liquidity risk it actually creates.

  1. AContingent draws can create liquidity outflows in stress, so the buffer cost should be borne by the business that generates the commitmentCorrect
  2. BUndrawn lines generate interest income that must be offset
  3. CRegulators prohibit lending without a charge on funded balances only
  4. DIt lowers the bank's required funding curve for term assets

Explanation

Committed facilities can be drawn when markets are stressed, requiring the bank to hold liquidity buffers. Allocating this cost to the originating business aligns incentives with the liquidity risk it creates. Undrawn lines earn no interest, and there is no such prohibition.

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