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

A bank's treasury operates a liquidity transfer pricing (LTP) framework. A business unit originates a 5-year fixed-rate term loan funded by the central treasury. Which approach best reflects better-practice LTP for pricing the loan's liquidity cost?

The loan should be charged a transfer rate that reflects its expected liquidity profile, using the term funding cost at a matching tenor. This makes the business unit bear the real cost of funding a long asset, rather than an average or overnight rate that hides the mismatch.

  1. ACharge the loan the bank's average cost of all funding, regardless of tenor
  2. BCharge a funds transfer rate based on the loan's expected liquidity profile, reflecting the term funding cost at a matching tenorCorrect
  3. CCharge the overnight interbank rate because the treasury rolls funding daily
  4. DCharge no liquidity cost because credit risk is already priced in the loan spread

Explanation

Better-practice LTP charges assets a term liquidity premium matched to their expected liquidity profile, so the business bears the true cost of funding a long-dated asset. Using an average cost or overnight rate hides the tenor mismatch and encourages excess long-term lending.

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