Integrating fund transfer pricing with liquidity and interest rate risk management

Integrating fund transfer pricing with liquidity and interest rate risk management

By Hadrien Van Der Vaeren, Senior Manager, Avantage Reply

Can you please tell the Risk Insights readers a little bit about yourself, your experiences and what your current professional focus is?

As a Senior Manager within Avantage Reply – a risk, finance and compliance consultancy – I support clients with practical implications of risk and finance related change initiatives. For slightly over a year, I have been working on the implementation of a new asset and liability system at a European bank. My role in this project is to lead a team ensuring the appropriate implementation of the ALM metrics for liquidity management, interest rate risk management and fund transfer pricing.

Prior to this, I worked on various projects in the treasury and risk functions at the UK and European banks, mainly focusing on market risk, counterparty credit risk, interest rate risk and liquidity risk.

What, for you, are the benefits of attending a conference like Risk EMEA 2019 and what can attendees expect to learn from your session?

I try to keep up with all the trends with respect to risk management for financial services. However, I tend to focus primarily on the trends affecting my areas of expertise. The two days at Risk EMEA offer a valuable opportunity to take a step back and see the wider picture and the interconnections.

As such, I hope that those attending my session will understand the key developments that drive the evolution of asset and liability management. I will also highlight challenges we faced when implementing a new ALM platform and provide some takeaways based on the experience.

In your opinion, what are the main implementation challenges of a modern fund transfer pricing mechanism?

The main challenges faced related to the variety of entities, businesses and regulators involved in the process. Ideally, you want to use a uniform approach, e.g. your liquidity risk model should be the same for a sight deposit by counterparty A. However, this is not always possible because regulators may impose constraints, or different businesses may justify a different approach. Managing these differences such that you strike a balance between consistency, usefulness to the business and easiness to maintain is a challenge. In addition, implementing fund transfer pricing comes with the traditional IT project challenges of data quality, data timeliness and data interpretation (correctly understanding the meaning of the data) as you need sufficiently accurate and granular data for all your positions.

What are the key considerations that need to be made when ensuring consistency between transfer pricing, liquidity management and interest rate risk management?

One key objective of a modern fund transfer pricing mechanism is to create the right incentives for the business by accounting for the risks and benefits of the funding sources and their utilization. As such, you try to remunerate or charge the business based on the risk associated to each position. This requires the integration of interest rate risk and liquidity models into fund transfer pricing.

What challenges and opportunities can financial institutions expect to face when managing the business vs risk view?

Fund transfer pricing affects directly the profit and loss of the various businesses within a bank. As such, acceptance of the methodology by the business is essential and this methodology must enable the business to provide competitive prices. At the same time, the fund transfer prices must provide the asset and liability department with sufficient resources to enable them to manage interest rate and liquidity risks. Finally, the pricing should incentivise the business such that it helps to meet regulatory requirements (including LCR and NSFR).

How do you see balance sheet management evolving over the next 6-12 months?

I see two key drivers for the coming months. From a business perspective, rates are likely to stay low for a prolonged period of time. Treasurers and the business will probably reassess products and models to optimize the balance sheet and revenue. From a regulatory perspective, the ECB and the EBA continue to focus on liquidity risk and interest rate risk, including the liquidity stress test in 2019. This will put pressure on the respective teams in banks to deliver the stress test, to remediate any issues raised and to address any observations made.

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