FRM Part II · FRM Exam Part II · Liquidity Transfer Pricing: A Guide to Better Practice
A bank's treasury is designing a liquidity transfer pricing (LTP) framework. Which feature best reflects the better-practice principle for how liquidity costs and benefits should be allocated to business units?
Better-practice liquidity transfer pricing charges business units for the liquidity their assets and contingent commitments consume and credits units that raise stable funding. This makes internal prices reflect actual liquidity risk and aligns business incentives with the bank's risk appetite, unlike central retention or arbitrary allocations.
- ALiquidity costs are charged to business units on assets and liquidity benefits are credited to units that raise stable funding, so that internal prices reflect the true liquidity risk each activity createsCorrect
- BAll liquidity costs are held centrally in Treasury to keep business unit profitability simple and free of funding noise
- CLiquidity costs are allocated equally across business units in proportion to headcount
- DOnly the assets side is charged, because deposits do not create any liquidity value to the bank
Explanation
Better practice requires that LTP charge units for the liquidity they consume and reward units for liquidity they provide, aligning incentives with the bank's risk appetite. Keeping costs in Treasury hides the true economics and distorts decisions. Headcount-based allocation bears no relation to risk taken, and ignoring the value of stable deposits creates a one-sided framework.
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