Author: Gilberto Chavez-Velazquez
Degree: M.S. in Financial Engineering
Year: 2021
Advisory Committee: Dr. Zachary Feinstein, Dr. Ionut Florescu

Abstract: We describe an optimization driven Funds Transfer Pricing (“FTP”) framework for a Financial Institution subject to TLAC, NSFR, LCR , and other regulatory and total asset constraints. After deriving the optimal asset and funding liability mix where the marginal revenue and marginal cost curves are equated, we find the optimal FTP debit and credit rates from Treasury to the Bank’s Lines of Business via a Schmaltz-type Advanced FTP framework. The framework incorporates deterministic, stochastic, and jump process components and is implemented via a Case Study. We find that the typical Financial Industry practice of optimizing FTP in isolation without first analyzing the asset/liability allocation mix can lead to internal arbitrage and a violation of the Fisher Separation Theorem.

In addition, the document describes the current Financial Industry practices surrounding the methodologies for the calibration of Stable Non-Maturity Deposit (“NMD”) Balances, Pass-through Rates, and Attrition rates necessary to estimate the magnitude and timing of contractual and behavioral cashflows in their maturity ladder. The incorporation of behavioral assumptions, stochastic rates, and contingent liabilities affect the liquidity and capital allocation decisions as well as the FTP rates. These assumptions are critical to satisfy the regulatory asks as evidenced in FRB SR 16-3, as well as other Basel requirements.