FRM Part II · FRM Exam Part II · Liquidity Transfer Pricing: A Guide to Better Practice
A mid-sized bank has no liquidity transfer pricing (LTP) framework. Its retail branch managers are rewarded on net interest margin, and they aggressively gather long-dated fixed-rate loans funded by overnight deposits, appearing highly profitable. Which primary objective of an LTP framework would most directly address this problem?
The relevant objective is allocating liquidity costs and benefits to business lines so that performance reflects the liquidity risk each creates or provides. Charging long loans a term liquidity premium removes the hidden subsidy from short-term funding and aligns incentives with the bank's liquidity risk appetite.
- AAllocating the cost and benefit of liquidity to business lines so that their performance reflects the liquidity risk they create or provideCorrect
- BEliminating all interest rate risk from the banking book by matching repricing dates
- CReplacing regulatory liquidity ratios with internal limits
- DReducing the bank's tax liability by shifting profits between entities
Explanation
LTP charges business lines for the liquidity they use and credits those that supply stable funding. This removes the hidden subsidy that makes long-dated loans funded with short-term deposits look profitable. The other options describe interest rate hedging, regulation substitution or tax planning, which are not LTP objectives.
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