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

A bank's LTP framework credits stable retail deposits with a liquidity premium based on behavioral maturity of 5 years, while the contractual maturity is on demand. During a stress, deposit outflows far exceed the behavioral assumption. Which is the best implementation response?

The best response is to back-test and review behavioral assumptions under formal governance, incorporate stress-adjusted estimates and escalate to the ALCO. This keeps deposit credits realistic without discarding behavioral modeling, which would undervalue stable funding and distort incentives.

  1. AAbandon behavioral modeling and credit deposits at overnight rates only
  2. BCredit deposits with the longest asset tenor to preserve incentives
  3. CRegularly back-test and review behavioral assumptions under governance, with stress-adjusted estimates and clear escalation to the ALCOCorrect
  4. DLet each branch set its own behavioral maturity for deposits

Explanation

Behavioral assumptions are inherently uncertain, so they need ongoing validation, stress considerations and senior oversight. Dropping them entirely would undervalue stable funding and distort incentives, while crediting the longest tenor or branch discretion would overstate value and invite gaming.

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