Branch Profitability

Transfer Price Mechanism

 TRANSFER PRICE FOR BRANCH:WHY
 In a branch banking system: Multi-Functional-
Deposits, Advances, Fee-based services.

 Multi-layer functional system- each constituent

should be profitable.

 Profitability and efficiency- Effective transfer

price mechanism-
 Objectives of TPM
 TPM should be designed to strike a balance between
profitability and efficiency.
 Evaluation of branch performance - TPM
– Funds mobilized by branches are treated as “Funds Lent
to HO”
– Funds deployed by branches are treated as “Funds
Borrowed from HO”.
– Head Office compensates branches for transferring
surplus funds and charges deficit branches which use
these resources at a notional rate. These notional rates /
prices are known as Transfer Price.
– TPM should act as a policy instrument on the part of Head
Office to signal goals of the organization.
– It should provide incentives to branches so as to motivate
them to work for organizational goals
 TPM: In a Dynamic World
 In the present competitive environment, efficiency
has become the cornerstone of business,
particularly, in the banking business. Banks have
started thinking in terms of each branch becoming a
mini-profit centre which prompts for a more
dynamic Transfer Price Mechanism where in the
economic dynamic including interest rates, liquidity,
credit off-take, market potential, etc. have to be
factored into the system in order to enable the
management to direct its resources more efficiently.
 TPM: Constraints
 Multiple functions of branches
– Deposits mobilisation
– Credit offtake
– Fee-based income generation
– Low cost deposits
– NPAs reduction
 Regulatory functions
– Agricultural credit
– Export credit
– SMEs credits
– Other directed credit
– Capital Cost
 Incentive functions
– Low cash-holding
– Low operating cost
– Cash recovery from NPAs
 TPM: How to Design
 TPM :
– a Market Determined rate
– factor all incentives and penalties
– It should signal organizational objectives

Market determined rates are:

 Treasury bills rate
 Call Money rates
 CBLO Rates
 One month ZCYC rates
 TPM: How to Design
What are the incentives?
– Low cost SB and Current Deposits
– Targeted Advances
– Retail Lendings
– Priority Sector lendings
– Export credit
– NPAs Recovery
– Overhead Efficiency
– Rural and Semi-urban Branches
– Credit/Kissan Card Business
What are the Penalties?
– Excess Cash-holding
– NPA
 Yield Curve Based Monthly TPM
Avg. Deposit Rate :Min Yield in 1Yr Time Bucket of ZCYC

Intermediation Cost: Opt. Cost to Avg. Assets

Depository Insurance cost: Insurance Premium to Dep.

Cost of CRR Maintenance: Avg.dep.rate* CRR %

CRAR Cost (12%)= 12% * Tier-II Bond cost

Operating cost of Rural Branch: Opt.cost/avg.assets

Targeted ROAs

Average Projected Assets

 Yield Curve Based Monthly TPM
Actual cost of Deposits:
– Minimum of Yield of ZCYC
– Intermediation cost
– Depository Insurance cost
– CRR Cost
HO-transfer rate:
– Actual Cost of Deposits
– Targeted ROA
– Less CRAR Cost
HO-Borrowing rate:
– Actual Cost of Deposits
– Targeted ROA
– CRAR Cost
HO-Borrowing rate for SLR:
– Actual Cost of Deposits
– Targeted ROA
 Yield Curve Based Monthly TPM
Compensation & Penalties
FCLR Lendings= (HOBR- Avg.FLCR)*FCLR Amt
Agri.Lendings = (HOBR –Avg.Ar rate)* Agri.Lending
Rural Br. OH =(Rural Br.OH-Bank’s OH)*Rural Bus.
Excess Cash =( Branch Cash- Min.Cash)*HOBR
NPA = Incremental NPA * HOBR
Special Incentives
NPA Recovery = Cash Recovery * A1
SB Deposits = SB Deposits * A2
Current Deposits = Current Deposits * A3
Fee- Based Income = Fee Income * A4
A1+A2+A3+A4=1 & Total Incentive = HO Surplus