Training center

Course: Banking Resources: Prime Cost (seminar 4 hrs)

Prime cost calculations determine not only products’ costs to clients in the real sector but to structural risks — interest and liquidity — that a bank faces as well. It is an accepted fact that Western Europe’s financial problems in 2008-2013 stemmed in many ways from inefficient transfer rate systems. This makes prime cost the second most important subject to discuss after capital adequacy and liquidity risks. Numerous detailed documents of international consultants, Basel Committee and other institutes promoting financial stability address this topic.

The seminar aims at giving students an understanding of different approaches to setting up a transfer rate system. Transfer rate curves will be discussed along with accounting for risk costs, e.g. liquidity risk. Special attention will be given to liquidity buffers and how to factor their costs into prime cost calculations. Examples of several Russian and foreign banks’ transfer pricing systems will be analyzed.

Main program issues

  • Finance computations for business processes: processes for an effective assets and liabilities structure (bank balance, analysis of accepted structural risks, preparation and first estimates for deals, capital adequacy); requirements for business processes; requirements to methodology in consequence.
  • Financial instruments: typology, risk factors, interrelations; interest rate curves (for interest and currency swaps and bond yields); how to use indicators with a bank’s interest rate curve.
  • Transactions on the financial market: date agreements; standard deal terms in specific currencies.
  • Building an interest rate curve from existing indicators: interest options, curve versions, parametric and non-parametric approaches, parametrization choices (the Swensson-Nelson-Siegel model); comparing approaches, their benefits and drawbacks; creating a ruble curve: NDF+CIRS, MosPrime+IRS, IRS+Z, FLB+Z.
  • Alternative methods of producing resource prime cost curves: functions of a system of resource prime cost curves; requirements to interest rate curves; how to determine prime cost based on current resources, market rates of main funding sources, market deposit rates; entering liquidity risk into prime cost formulas; liquidity buffers; what to do in a absence of indicators.
  • Valuation of interest risk and its role in pricing: valuation of risks of specific net present value change and net interest income change; value-at-risk (VaR) vs. EaR (earnings-at-risk); what role risk plays in interest curves.
  • Pricing: for deposits; for current accounts; for loans, loan risk; for investment portfolios, market liquidity accounting.