Imagine you have
two different companies within the same organization. One is a manufacturing
company located in Country A, and the other is a sales company located in
Country B. These companies engage in transactions with each other, such as
selling and buying goods or services.
Now,
matched-term transfer pricing is a way to determine how much the manufacturing
company should charge the sales company for the goods it provides. The goal is
to set a fair price that reflects the value of the goods and ensures both
companies benefit.
To determine
this fair price, matched-term transfer pricing considers the terms and
conditions of the transaction. It looks at similar transactions happening
between unrelated companies in the open market. For example, if the
manufacturing company sells similar goods to other companies in Country A, the
price it charges the sales company should be similar to what it charges those
other companies.
This approach
ensures that the transfer price is based on market conditions and not
manipulated to shift profits or avoid taxes. It helps prevent one company from
unfairly benefiting at the expense of the other.
In simpler
words, matched-term transfer pricing is a method to set a reasonable price for
goods or services exchanged between different companies within an organization,
by comparing it to what similar goods or services would cost in the open
market. It aims to be fair for both companies involved.
Let's explain
matched-term transfer pricing in the context of the banking sector.
In the banking
industry, there are often different departments or divisions within a bank that
engage in transactions with each other. For example, there could be a lending
department that provides funds to the retail banking division, which then lends
those funds to individual customers.
Matched-term
transfer pricing in banking refers to the process of determining the appropriate
interest rate at which one division within the bank lends or borrows funds from
another division. This interest rate should be fair and reflective of market
conditions to ensure that both divisions benefit.
To determine the
fair interest rate, matched-term transfer pricing considers factors such as the
prevailing market rates for similar loans or deposits, the risk associated with
the transaction, and the term or duration of the loan or deposit. It aims to set
an interest rate that aligns with what the bank could earn or pay if it had
engaged in the same transaction with an external party in the market.
This approach
helps prevent unfair advantages or disadvantages between different divisions of
the bank. It ensures that the cost of funds and the revenue generated from
internal transactions are in line with external market conditions.
In simpler
terms, matched-term transfer pricing in banking is the process of determining
the appropriate interest rate for internal loans or deposits within a bank,
based on the prevailing market rates and other relevant factors. It ensures
fairness and consistency in the pricing of internal transactions, similar to
how external transactions would be priced.
Here's an
example with multiple scenarios emerging in a year, along with the
corresponding answers in a table
In this example,
we have four different scenarios emerging throughout the year, each with its
own market interest rate for 1-year loans. The bank determines its internal
transfer rates for 1-year loans and deposits based on these scenarios. The goal
is to set fair rates that align with market conditions.
Let's analyze
each scenario and fill in the table:
Scenario 1: The market interest rate
for 1-year loans is 5.0%. The bank decides to set its internal transfer rate
for 1-year loans at the same rate to reflect market conditions. For 1-year
deposits, the bank sets its internal transfer rate at 3.5%, which is slightly
lower to incentivize internal deposits.
Scenario 2: The market interest rate
for 1-year loans decreases to 4.5%. In this case, the bank decides to set its
internal transfer rate for 1-year loans slightly higher at 5.5% to generate
more revenue internally. The internal transfer rate for 1-year deposits is set
at 4.0% to attract more internal deposits.
Scenario 3: The market interest rate
for 1-year loans increases to 6.0%. The bank aligns its internal transfer rate
for 1-year loans with the market rate at 6.0%. Similarly, the internal transfer
rate for 1-year deposits is set at 4.5% to attract internal funds while
remaining competitive.
Scenario 4: The market interest rate
for 1-year loans decreases to 4.0%. The bank maintains its internal transfer
rate for 1-year loans at the same rate of 4.0% to reflect the market
conditions. For 1-year deposits, the bank sets its internal transfer rate at
3.0% to encourage more internal deposits.
By adapting the
internal transfer rates for loans and deposits to match the changing market
conditions, the bank ensures that its internal transactions remain fair and
competitive throughout the year.
Please note that
the numbers used in this example are hypothetical and for illustrative purposes
only. In practice, banks consider various factors and conduct more
sophisticated calculations to determine transfer pricing rates.
