A Bank Within A Bank: How A Commercial Bank's Treasury Function Affects the interest rates set for loans and deposits

Aight now THIS was another bulletin where I learned a tremendous amount of a central concept, that I was never told by anyone at work. In fact I doubt many RMs or even BCMs know about this. The key eye-opening fact was that the bank’s treasury is a bank within the bank. I did NOT know that treasury borrows money from deposit-raising business lines (i.e. cash management in HLB) and lends it to loan-making business lines (i.e. the BCs in HLB). And FTP represents the transfer price of this internal bank’s interest rate (the BCs mark up the FTP when we charge our loan customers, while cash management marks down the FTP when they charge their deposit customers). The BCs get charged internally for borrowing money from treasury; whereas cash management gets an internal rebate when they source deposits. (Of course, BCs source deposits too, so I suppose our cost center gets an internal rebate whenever we source a deposit). I had zero idea of this mechanism. I did not know at all that whenever KL2 makes a loan, we have to borrow it from treasury and pay FTP; and whenever we source a deposit we receive an internal rebate! Or this process could be a matter of internal accounting only, so we, the RMs, do not need to log this in our books. Clearly, the accurate estimation or calculation of FTP plays an important role in ensuring that loans and deposits are sourced correctly according to the amount that ‘should’ be made. For example, if the bank were to underestimate FTP, then BCs would make too many loans and source too few deposits, and vice versa. And it’s easy to mis-estimate FTP, for as the result of the PRA (Prudential Regulatory Authority) survey of UK banks showed, many banks made 1 of more of the following mistakes in FTP practices: - Application of a single unsecured wholesale funding curve (and I presume it’s because this is convenient. For the single unsecured wholesale funding curve is presumably just the yield curve of the bank’s bonds. It is easy to see and easy to benchmark). - Application of a single blended secure and unsecured wholesale funding curve - A single blended rate applied to all new loans and deposits irrespective of maturity - Applying a single average COF to all assets and liabilities originated, irrespective of maturity Of course, banks may intentionally deviate from FTP in their pricing, e.g. intentionally pricing at a loss for strategic reasons to grab market share (or, in my recent experience, to window-dress our asset position for the FYE closing). It’s crucial to ensure that these deviations in pricing reflect the true economics of the business and not a mis-estimation of FTP. And this bulletin even cautions that a mis-estimation of FTP at one bank may have a small herd effect on other banks: if one bank prices lower (simply due to underestimating FTP), its competitors may follow it. An oversupply of credit thus follows. Of course, many questions remain after reading this excellent bulletin: 1) I wonder what method HLB uses to measure its FTP? Just the application of a single unsecured wholesale funding curve? Or a blended curve? 2) Why do we even need this treasury? We are one bank, no? Whenever a BC makes a loan, why can’t the bank just internally transfer reserves to that BC’s account for free? Why do we need a transfer price? 3) Following from 2), the existence of this transfer price has fascinating Hayekian and Coasean implications. It is argued by some, e.g. Dwarkesh Patel, that the existence of massive tech firms, or massive firms in general, prove that you can do command-and-control at a large scale. But I learned now that big banks must rely on internal transfer prices to coordinate resources! So, within a FIRM, i.e. a centrally planned organization, there must exist a market system! A bank would struggle to centrally coordinate resources even within the bank itself and must rely on a market system embedded in the bank. And if other firms have transfer prices as well, which I’m fairly sure they do, because I’ve heard that corporations, especially MNCs, must do lots of transfer pricing, that means that you cannot command-and-control at a large scale without a market or a price system.