Funds Transfer Pricing

The funds transfer pricing (FTP) methodology determines the cost of funds associated with the lending and borrowing from a financial institution (for example, a bank) while considering liquidity, interest rate and currency risks.

This mechanism is therefore also a part of the internal process that sets interest rates on the retail and commercial products of a bank. FTP measures the performance of the bank’s deposit-raising (borrowing) and funds-advancing (lending) business units by constructing and evaluating deposits and loans profitability indicators (for example, FTP rate, costs of funding, net interest margin (NIM), and net interest income (NII)). The bank's treasury departments usually determine the following different FTP rate types:
  1. Rates charged for providing funds to loan-giving business units
  2. Compensation rates for funds received from deposit-raising business units
To meet the regulatory and functional needs for a sound FTP system, financial institutions can implement the Funds Transfer Pricing tool integrated in SAP Profitability and Performance Management that enables you to do the following:
  • Generate various cash flows on both fixed and variable rate instruments using Flow Generation and Rate Modeling rule types
  • Construct FTP cost of funds yield curve using multiple interpolation and smoothening methods
  • Calculate various durations on selected instruments
  • Apply cash-flow-based FTP rate calculation methods (term-weighted matched maturity, NPV approach, and so on)
  • Apply non-cash-flow-based FTP rate calculation methods (caterpillar or strip funding approach, weighted average rates, pool rate assignment, and so on)
  • Use or construct other fund and liquidity transfer pricing approaches

Various rule and line types of the FTP function enable the implementation of the intricate methodology outlined above.

Rule Types

The following rule types are available:

  • Durations

    Calculates three different types of duration. Their outputs are of similar numerical value, but theoretical concepts behind calculations and the interpretation of results differ as do the practical applications.

  • Flow Generation

    As an umbrella for six different line types, this rule type generates principal cash flows according to amortization pattern or flexible individual cash flow for disbursement, except principals by Single Flow line type. Note that interest cash flows are handled by the Rate Modeling rule type. Therefore, by combining different line types of Flow Generation and Rate Modeling, SAP Profitability and Performance Management is able to generate various types of future cash flows in real business scenarios.

  • Flow Merge

    Joins financial position master data from one function with relevant transaction or business event data from another function that indicates exceptional cash flows.

  • Formula

    Applies formulas and HANA SQL functions that return numeric and string values to output fields.

  • Market Interest Rate

    Determines the FTP/LTP rate (the rate at which a bank extends or accepts loans to or from its internal departments) with several calculation steps in the logic sequence of the Net Present Value Approach shown below.

  • Matched Maturity

    Generally, as an extension of the multiple pools FTP methodology, this approach involves the coordination of a financial institution’s cash inflows with its cash outflows based on the maturities of its assets and liabilities. Specifically, it calculates the FTP rate by matching due dates of (asset & liability instruments’) principal cash flows to the marginal cost of ffunds curve (also referred to as the FTP curve) rates of corresponding maturity.

  • Rate Modeling

    As an umbrella for six different line types, this rule type covers various areas: it generates interest cash flows, interpolates rates on a yield curve, creates forward rates and determines daycount. Since the Flow Generation rule type generates principal cash flows in combination with Rate Modeling, SAP Profitability and Performance Management can generate various types of future cash flows in real business scenarios.

  • Running Total

    This rule type sequentially sums a selected field and updates this sum (also referred to as the “running total”) for each row by adding it to the previous running total. It is used in finance to calculate, for example, loan principal outstanding that is the basis for interest calculations.

  • Series Generation

    This rule type generates series data by providing several parameters such as Step Size, Series Type, Period From and Period To.

  • Strip Funding

    Divides the net present value of principal payments by the sum of the term-accrued period-end principal balances, while discounting both with matching funding rates to calculate the FTP rate.

  • Weighted Average Rate

    This approach centers on the logic used to split a financial position into components. The chosen logic mandates matching of each part to different factors (weights) and funding rates – the only variables in the simple FTP weighted average rate calculation (WAR).

Rule Lines

Durations

The following rule lines are available:

  • Macaulay Duration is the weighted average maturity of future cash flows of a financial instrument. The weight of each cash flow’s maturity is determined by dividing the present value of the cash flow by the net present value of the observed instrument. Under the assumption of yearly compounding, Macaulay duration is given by

    where “CFi” is the (absolute) amount of the i-th cash flow, “Ti” is the respective maturity of the i-th cash flow and “r” is the yield to maturity of this financial instrument.

  • Modified Duration is a measure of price sensitivity, defined as the percentage derivative of price with respect to yield to maturity and compounding method. Under the same assumption, modified duration is given by

  • Fisher-Weil Duration: If rates from a zero coupon yield curve are used instead of the yield to maturity, the Fisher-Weil duration is calculated with the same formula instead of Macaulay duration.

Flow Generation

The following rule lines are available:

  • Periodic Fixed Amount Flow

    Calculates principal payments that, in combination with interest payments, would compose a fixed periodic total of equal value in all periods (but with constantly changing principal and interest values). Principal calculation is done in two steps:

    First, the amortizing factor for n-th principal payment (An) is found:

    Where “r” is the nominal interest rate, “f” is the payment frequency (number of principal payments in a year), “tn” is the term of the n-th principal payment, and “T” is the term of the last principal payment determined by the maturity.

    Then, the amortizing factors are used to calculate the periodic principal payments (Pn):

  • Periodic Fixed Even Flow

    Calculates equal principal payments (hence “even flow”) by dividing the total outstanding amount on the maturity date with the total number of payment periods.

  • Periodic Fixed Interest Rate Flow

    Calculates principal cash flows as the simple product of a selected rate and selected start value, except for the last payment, which is the difference between start value and sum of previous principal payments.

  • Periodic Fixed Rate Flow

    This line type’s output, principal cash flow, is determined by subtracting (1) interest payments from (2) total cash flows, except for the last payment which equals the remaining principal of the previous period:

    1. Interest is the product of the input field Rate and the remaining principal of the previous period.

    2. Total cash flow is the product of the input fields Repayment Rate and Start Value, with the exception of the last payment, which is the sum of the remaining principal and the last interest payment.

  • Periodic Fixed Value Flow

    This line type’s periodic cash flows are equal to the amount set in the input field Value. The exception to this is the last payment, which is the difference between the amount set in the input field Start Value, the sum of all previous periodic cash flows, and the amount set in the input field End Value.

  • Single Flow

    Line types described above generate multiple output rows as principal and interest calculations across all periods. The Single Flow line type generates only one output row, which makes it suitable for special or atypical cash flows like balloon/bullet payments, administration fees, disbursements, and so on.

Flow Merge

The following line type is available:

  • Include Events to Flows

    Joins an instrument’s master data (for example, origination amount and date, currency) from one function with its tripartite event data (cash flow amount/type/date) from another function into one data record (hence “flow merge”).

Market Interest Rate

The following line types are available:

  • Effective Yield Rate

    Calculates continuous effective interest rate with respect to a given set of future cash flows associated to a financial position in two steps. In the first step, it calculates the internal rRate of return (IRR) as the root of the following equation:

    where:
    • “Pi” is the i-th (re)payment including principal and interest
    • “Ti” is the term of the i-th payment counted in days, for example, the days from starting date to i-th payment counted regarding a given interest calculation method
    • “d” is the total number of days in a year regarding the given day count convention. For example, d = 360 for Act/360, 30/360; d = 365 for Act/365, and so on.

    In the second and last step, the system calculates and displays the continuous effective interest rate “rceff”, based on the assumption of continuous compounding, as determined by the following formula:

    where “ln” is the natural logarithm.

  • Effective Capital over Time

    Calculates the effective capital as the difference between the continually compounded initial capital (inflow) and the sum of subsequent repayments (outflows). Each period’s effective capital is the difference between the previous period’s effective capital (that is continually compounded) and the current period’s repayment. The following equation resembles this relationship:

    where i = 1,…,n and “ECOT0” is the initial amount invested (for example, the total amount of a loan).

  • Capital Growth

    Capital growth for a given period equals the ratio of (i) the product of the previous period’s effective capital and the continuous effective rate for the elapsed period (hereinafter numerator) and (ii) the continuous effective interest rate (hereinafter denominator). The calculation is therefore similar to that of perpetual annuity: periodic income (numerator: product of effective capital and effective yield rate for the elapsed period) is divided by the effective yield rate (denominator).

    where i = 1,…,n. By convention CG1 = 0.

  • Capital Growth Net Present Value

    Returns the simple product of an already calculated discount factor and capital growth to generate present values of capital growth for each period.

  • Net Present Value

    Returns the simple product of an already calculated discount factor and cash flows to generate the present value of future cash flows.

  • Net Present Value Sum

    Returns the sum of the present value of cash flows, which is the NPV of cash flows.

  • Margin Spread

    Determines margin spread as the ratio of cash flow NPV and capital growth NPV. Margin spread is the rate that is usually charged above FTP rate to ensure that each investment (for example, an extended loan) generates positive returns. From a financial institutions’s perspective, margin spread is the difference between the borrowing and lending rates in deposits or the difference between the cost of borrowing and return from lending.

  • FTP Rate

    Determines the funds transfer pricing rate as the difference between continuous effective interest rate and margin spread. FTP is the rate at which a bank extends (or accepts) loans to (or from) its internal departments.

  • Market Interest Rate

    This line type contains all of the Net Present Value approach’s outputs as described above.

Matched Maturity

Matched Maturity, also known as “Term Weighted Matched Maturity”, calculates the FTP rate by matching principal repayments’ due dates to the rates on the marginal cost of funds curve (or. FTP curve) of same maturities, while treating the product of corresponding terms and principal repayments as weights:

where “Pi” is the i-th principal payment amount relating to the i-th term “Ti” and “ri” is the prevailing interest rate relating to “Ti” retrieved from the specified FTP rate curve, and “n” is the total number of principal payments.

Use “Rate Modeling” or “Interpolation” rule types to generate the FTP curve, the main prerequisite of the Matched Maturity approach.

Rate Modeling

The following rule lines are available:

  • Daycount

    Calculates the number of days between two dates: starting date(s) of input field Date and ending date(s) of input field Curve Date. The calculation also depends on daycount basis, like actual/actual, 30/360, and so on.

  • Forward Rate

    Derives forward rates from spot rates of a selected yield curve by non-arbitrage principle using the equation below:

    where
    • “rx+y” is the spot rate of a zero-coupon bond of longer maturity term “tx+y”
    • “rx” is the spot rate of a zero-coupon bond of shorter maturity term “tx”.
    The following table compares derivation and application of spot and forward rates:
    Spot Rates Forward Rates
    Zero-coupon treasury yields Derived from spot rates
    Today’s price (or interest rate) of immediate transaction Today’s price (or interest rate) of transaction to occur in the future
    Discounts a future cash flow to the present date Discounts a distant future cash flow to a closer future date
    Example: 3-month and 12-month zero-coupon rates Example: 9-month rate expected 3 months from now (implied by 3-month and 12-month zero-coupon rates)

    Non-arbitrage principle means that the forward rate shall equal the future spot rate. For example, a longer-term spot rate (for eample 12 months) shall equal compounded return of the shorter-term spot rate (for example 3 months) and the remaining-term forward rate (for example 9 months).

  • Lookup Rate by Interpolation

    Linearly interpolates rates of a yield curve (of the Lookup tab) on dates from the input field Date (of the Input function) and assigns them to the Input function’s instrument(s) of matching characteristic values for curve ID, validity date, and currency.

  • Periodic Fixed Interest

    Produces periodic interest ordinarily using a set of cash outflows (for example disbursements) and cash inflows (principal repayments) as input. Specifically, the calculation applies the fixed periodic interest rate to the instrument’s remaining value (outstanding balance) – usually a difference between initial disbursement and the sum of subsequent principal repayments.

  • Periodic Variable Interest

    Produces periodic interest, ordinarily using a set of cash outflows (for example disbursements) and cash inflows (principal repayments) as input. Specifically, the calculation applies the variable periodic interest rates looked up from a certain interest rate curve to the instrument’s remaining value (outstanding balance) – usually a difference between initial disbursement and the sum of subsequent principal repayments.

Strip Funding

Strip Funding calculates the FTP rate as the ratio of (i) NPV of principal payments discounted using maturity matching funding rates by annual compound method and (ii) the sum of discounted and term-accrued principal balances remaining at each period.

where “B0” is the initial balance on FTP pricing date, “Bi” is the outstanding closing balance of the payment period i. “Pi” is the principal payment amount of this payment period. “Lambdai–1” is the accrual factor in year for the whole period i. And “di” is the discount factor derived from a given FTP reference curve by annual compound method.

Weighted Average Rate

This approach entails four steps:

  1. Splits a financial position into components according to a certain logic (like differing behavioral tendencies of position’s parts). The chosen logic mandates the remaining steps.

  2. Assigns weighting factors (percentages or amounts) to each part.

  3. Selects a suitable marginal cost of funds curve and assigns relevant funding rates to each component.

  4. Calculates FTP (WAR) as the ratio of
    • product sum of factors (fi) and corresponding funding rates (ri) and
    • sum of factors (fi) as shown in the equation below.

This rule line type calculates the average funding rate from an FTP curve weighted by term – a special variant of the term-weighted matched maturity method. It is also a non-cash-flow transfer pricing method for non-maturity positions like checking, savings, money market, and credit card accounts. These kinds of non-contractual cash flow balances can behave both as long and short maturities, and can be split accordingly and assigned a respective long-term and short-term interest rate.

Procedure

Function Access

Follow the steps below to access the Funds Transfer Pricing function:

  1. In the client where SAP Profitability and Performance Management is installed, choose Start of the navigation pathSAP Menu Next navigation step Profitability and Performance Management Next navigation step Modeling Next navigation step Start My EnvironmentsEnd of the navigation path.

  2. The Environment screen appears in a separate browser window. Choose an existing environment and continue. Within the environment, you can set up the newly added function.

Function Configuration

Follow the steps below to configure the Funds Transfer Pricing function:

  1. In edit mode, configure the following required fields in the header.

    • Result Handling
    • Suppress initial Result
    • Include original Input Data
    • Result Model Table

  2. Define the input function to be used on the Input tab.

  3. Define the function to be used on the Lookup tab, if needed.

  4. Define the fields to be used on the Signature tab.

  5. On the Rules tab, you can define the rule and line types of the Funds Transfer Pricing function. For more information about the available rule types, see the Rule Types section above.

    Proceed as follows to configure the rules:

    1. On the Rule tab of your Funds Transfer Pricing function, choose (Add).

    2. The Add Details screen is displayed. Enter the following information:
      • Add Level
      • Rule
      • Rule Type
      • Description

    3. Choose OK.

    4. Select the created rule.

    5. On the Rule Lines tab of the created rule, choose (Add).

    6. The Add Details screen is displayed. Enter the required information.

    7. Select the created rule line and enter the required information.

  6. Define the checks to be used on the Checks tab, if needed.

  7. Choose Save and then choose Activate.

Related Information

  • For more information about common aspects of SAP Profitability and Performance Management functions, see Concepts for Key Users.

  • For more information on how to add and remove functions in SAP Profitability and Performance Management environments, see Function Hierarchy.