The challenge of an adequate funds pricing model

By André Weber.

This article deals with the challenge imposed to Treasury and Commercial areas when it comes down to pricing of funds.

The growing need for an adequate identification of expenses and income in financial institutions provoked a strict segregation among the areas and brought as a consequence one of the major challenges currently in the banking environment: the definition of an internal pricing model which can serve as the basis for all commercial deals. This is not free of passionate discussions between the commercial areas and Treasuries in each bank.

From one side there is the need to correctly and efficiently reflect the funding cost of an institution and on the other side a Treasury area that has to take into account not only the incurred funding cost but as well the indirect cost. The latter have to do with regulatory requirements, also linked to prudence in order to prepare the institution for unpredictable and adverse events.

Ultimately this has also to do with achieving an adequate level of return in each deal, where a more competitive funding price could mean closing or losing a deal. The problem gets worse when we deal with subsidiaries or branches of foreign institutions, which commonly have a relevant portion of its funding raised abroad and which is denominated in foreign exchange. This also means many times that this funding comes at more competitive cost than domestic one or its national equivalent in the same reference currency.

Which criterion should be adopted? The effective cost of funds? The opportunity cost? A combination which reflects different sources and terms? By currency? By product?

Domestically and especially in Brazil, depending on which area the business is in, there are other variables which should be considered and that can significantly change the pricing model, as e.g. products with governmental subsidies or even products linked to a specific sector or segment.

Finally there is also the institution’s strategy, which should be the guiding factor for all investment decisions, priority product lines and consequent margins, all of this impacting the whole pricing chain.

The essential is to find a model that is fully understood by all stakeholders which is based on concrete, transparent and mainly viable aspects.

The adoption of a simple and practical model is, in most of the cases, the best way which enables the various involved areas to focus on what is really essential: sustainable growth of your organization.

SP April 2013.

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