16 March 2009
Value placed on transfers within an organization, used as a means of allocating costs to various profit centers. Transfer pricing is used widely in multioffice banks and bank holding companies, serving these important functions: (1) price setting for services performed by business units; (2) a means of evaluating financial performance by business units; and (3) determining the contribution to net income by profit centers in the organization.
An example is determining a bank's internal cost of funds, or the cost assigned bank deposits supplied by retail branch offices to its commercial lending division. The retail branches traditionally are suppliers of funds, and commercial lenders traditionally are users of funds. Transfer pricing schemes also are widely used in pricing bank holding company services supplied to affiliate banks, for example, check processing, data processing, and funds supplied by a holding company to a subsidiary bank or a nonbank affiliate company. In lending, transfer pricing can be used as a form of internal credit rationing, by arbitrarily assigning the lowest cost of funds to the least risky loans, encouraging lenders to make loans that are profitable to the bank as well as low-risk. Transfer pricing schemes generally follow one of three cost accounting approaches: (1) market price; (2) cost- based price, generally the marginal cost of funds; or (3) negotiated price, a price determined through negotiation by buyer and seller. Historic cost, on the other hand, normally is used for reference only, and generally is not used in internal pricing.
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