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

A bank gives a corporate client an undrawn committed revolving credit line. The treasury expects that in a stress event a meaningful portion would be drawn. Under better-practice liquidity transfer pricing, how should the contingent liquidity risk be handled?

The business unit should be charged for the cost of holding a liquidity buffer sized to the expected stressed drawdown on the undrawn commitment. Contingent exposures impose a real cost of readiness even before any draw occurs, so ignoring them would underprice the facility.

  1. AIgnore it until the line is actually drawn, because only funded balances create liquidity cost
  2. BCharge the business unit for the cost of holding a liquidity buffer sized to the stressed expected drawdown on the undrawn amountCorrect
  3. CCharge the client the full cost of term funding on the entire committed amount from day one
  4. DReduce the liquidity credit given to the bank's deposit-taking units by the committed amount

Explanation

Contingent commitments create potential liquidity outflows and require a buffer of liquid assets that has a carry cost. The charge should reflect the stressed drawdown assumption on the undrawn portion. Waiting until drawdown ignores the cost of being prepared, and charging full term funding on the whole commitment overstates the drawdown.

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