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In this article you get to know about Transfer Price Mechanism. This article is written after referring and reading more than 7 articles related to this subject.
INTRODUCTION TO TRANSFER PRICE MECHANISM
In the pursuit of profitability, which is crucial for the survival of any business organization, banks strive to ensure their own financial health. However, the challenges of competition, liberalization, privatization, and globalization have intensified the need for higher efficiency in the banking industry. Non-performing assets and narrowing margins have further added to the concerns. In this context, it becomes vital to assess the profitability and viability of bank branches accurately. One way to achieve this is through the implementation of a Transfer Price Mechanism.
1. UNDERSTANDING TRANSFER PRICE MECHANISM: EVALUATING BRANCH PROFITS
Transfer Price Mechanism is a systematic tool used to differentiate between loss-making branches and unviable branches. It aims to assess the profitability and operational efficiency of bank branches effectively. By implementing this mechanism, banks can gain insights into the true profit contributions and relative performance of their various divisions.
2. OBJECTIVES OF TRANSFER PRICE MECHANISM: ENSURING EQUITY AND STABILITY
The key objectives of Transfer Price Mechanism include:
a. Evaluating the true profit and operational efficiency of bank branches.
b. Equitably compensating branches involved in deposit mobilization and deployment.
c. Facilitating an equitable distribution of profits.
d. Establishing a stable source of funding over time.
3. OPERATING THE SYSTEM: TREATING RESOURCES AS FUNDS
Under Transfer Price Mechanism, the resources mobilized by bank branches are treated as funds lent to the head office, while advances given by branches are treated as funds borrowed from the head office. Fixed prices are set for these transactions. Various systems are currently in practice, including the unitary system, dual system, and multiple systems.
4. UNITARY SYSTEM: A SIMPLE APPROACH
The unitary system applies a single rate to the head office balance in the books, regardless of whether the balance is in debit or credit. While this system is straightforward, it fails to reflect the true performance of funds providers and users. Additionally, branches with heavy advances portfolios may show higher profits compared to deposit-oriented branches.
5. DUAL SYSTEM: INCORPORATING DIFFERENT RATES
In the dual system, two different rates are implemented: one for lending to the head office and another for borrowing from the head office. However, this system has its drawbacks. Branches with significant current deposits portfolios may show higher profits without paying interest on these deposits, while branches with heavy term deposits portfolios may exhibit lower profits due to the high interest rates associated with such deposits.
6. MULTIPLE SYSTEMS: BALANCING DEPOSITS AND ADVANCES
The multiple system acknowledges the equal importance of deposits and advances in branch profitability. This system assigns different weightages to the normal interest rates of deposits and advances. While this system offers a more comprehensive approach, it lacks consistency in branch profits and does not consider international banking practices.
CONCLUSION
While banks in India employ different systems for Transfer Price Mechanism, there is a need for a uniform approach to ensure comparability among branches. The Reserve Bank of India has advised banks to adopt Matched Funds Transfer Pricing (MFTP) gradually. This system aligns the transfer price with the market rate and incentivizes branches based on the difference between the branch-offered rate and the market rate for assets or liabilities of similar maturity. Moving towards MFTP can enhance the accuracy and fairness of evaluating branch profits.
In final words, implementing an effective Transfer Price Mechanism is crucial for banks to evaluate branch profitability, ensure equitable compensation, and maintain stability. By adopting a uniform and market-driven approach, banks can improve their decision-making processes and foster sustainable growth in the ever-evolving banking industry.
FAQs
Here are some frequently asked questions (FAQs) along with their answers about Transfer Price Mechanism
Why is Transfer Price Mechanism important in banking?
Transfer Price Mechanism is important in banking as it helps assess the true profit contribution and relative performance of different divisions within a bank. It allows for a fair evaluation of branch profitability, ensuring equitable compensation for both deposit-mobilizing and deploying branches.
How does Transfer Price Mechanism work?
Transfer Price Mechanism operates by assigning transfer prices to the resources mobilized and advances given by bank branches. Different systems are employed, such as the unitary system, dual system, and multiple systems, each with its own approach to setting transfer prices based on the interest rates of deposits and advances.
What are the objectives of Transfer Price Mechanism?
The objectives of Transfer Price Mechanism include evaluating branch profitability and operational efficiency, providing equitable compensation to branches, facilitating an equitable distribution of profits, and ensuring a stable source of funding over time.
How does the multiple system differ from other Transfer Price Mechanism systems?
The multiple system considers both deposits and advances to be equally important for branch profitability. It assigns different weightages to the interest rates of deposits and advances, aiming to balance the contributions of both in evaluating branch profits.
What is Matched Funds Transfer Pricing (MFTP)?
Matched Funds Transfer Pricing is an approach recommended by the Reserve Bank of India. It aligns the transfer price with the market rate, offering incentives to branches based on the difference between the branch-offered rate and the market rate for assets or liabilities of similar maturity. MFTP helps reflect market conditions and enhances the accuracy of evaluating branch profits.