Is funds-transfer pricing worthwhile? Community banks in high-growth mode often look to larger, more sophisticated banks to emulate their processes. Or, in some cases, the CEO has come from a large regional or national bank and is implementing what he has always done.
The one question to ask is: What kind of business decisions does the bank intend to drive as a result of these allocations? Few CEOs can answer. That’s because few decisions are driven by these numbers. Funds-transfer pricing is an internal measurement process used to allocate deposit funding costs between business units or branches that are either net providers of or net users of deposit funding. Banks use funds-transfer pricing to get a clearer picture of business unit or branch profitability. It’s also an element of overhead allocation: Banks that do funds-transfer pricing also typically “push down” overhead costs to the business units or branches based on an arbitrary formula.
Each branch manager should be measured on what he can control and to his adherence to the growth plan set during the budgeting and forecasting process. This includes goals for the mix of loan and deposit growth, total cost of funds, loan yields, non-interest expense items, and other factors. It does not include allocated corporate/holding company costs. When one starts incorporating allocations in the mix, the results can become clouded. Treat branch managers as business owners, requiring them to set performance figures, take ownership and drive performance of goals they can control. Giving them responsibility for costs they can’t control only jeopardizes performance.
If branch managers aren’t responsible for these costs, who should be? The person responsible for budgeting and managing them. If a bank has a data-processing operation, someone is in charge of that cost center. For banks pulling wholesale funding, a CFO or treasurer is responsible. These individuals are in the best position to predict, forecast and manage costs, and by holding them accountable, ownership stays where it belongs.
One of the biggest challenges with implementing funds-transfer pricing and cost allocations is that it is not an exact science, which encourages banks to continuously tweak the assumptions. So, how does one get a true indication of performance? For example, if a branch is showing a loss as a result of the allocation, most banks will play with the assumptions so the branch doesn’t look like it’s losing money. And, again, the big question remains: Is this information being used to make business decisions? It would be a rare occasion at a community bank for a branch to be closed because of what a transfer-pricing model indicates.
Another negative byproduct is that branch managers will focus on these allocations as a source of contention with senior management — even if the allocation figure is exactly what was budgeted. They argue that management can make the black box of allocation or transfer pricing anything it wants. So, instead of focusing efforts on meeting growth goals, branch managers will be focused on poking holes in the assumptions. Branch managers also act in their own economic best interest, for example, making deposit decisions driven by the allocated interest expense. These decisions may help their own incentive compensation goals, but hurt overall bank performance. Is all of this worth it? Banks also don’t post transfer-pricing information to the general ledger, and therefore have no year-to-year comparative accountability.
Some bankers believe one can’t get a “true” picture of branch profitability without transfer pricing and cost allocations. Although there is merit to that, perhaps a more holistic view is warranted. The branch is not a standalone bank. Each branch contributes to performance based on the strengths of its market. It’s similar to how a football coach measures his team. He can’t evaluate every player on his strength or speed, since each team member has different skills and contributions. The expectations and measurements differ, but all are equally important to the team. For a branch, it’s not about the net income number; it’s about whether managers are meeting budgeted growth estimates. For example, multi-branch banks have markets with low deposit rates. This is the market where managers want to increase deposits to maximize overall bank performance. But transfer-pricing figures may actually penalize this deposit-generating branch, rather than reward it. Bankers should spend time managing the real issues, not moving costs around or changing assumptions.
