Liquidity risk pricing is one of the most debated and complex topics in modern Asset & Liability Management (ALM). While, in theory, liquidity should be priced transparently and consistently across the balance sheet, in practice banks face strong competitive pressures to allow for marginal cost of funding.

In a recent interview for CeFPro, Arnau López (Senior Treasury Risk Advisor in Nfq, and Commercial Director of Alquid) shared a practitioner’s view on how banks can navigate term liquidity risk pricing in an increasingly regulated and competitive environment.

Understanding the Components of Liquidity Pricing

Liquidity risk pricing is generally built around two main components.

The first is the Term Liquidity Premium (TLP), which reflects the cost of securing stable, long-term funding. This component is closely linked to regulatory requirements such as the Net Stable Funding Ratio (NSFR) and is usually the most significant and controversial element of liquidity pricing.

The second component is Contingency Liquidity Costs, which relate to the cost of maintaining a liquidity buffer to withstand severe short-term outflows under stressed conditions. These costs are associated with compliance with the Liquidity Coverage Ratio (LCR).

While both components are essential, the TLP tends to generate the most debate, as it directly affects how funding costs are allocated to assets and business lines.

ALM Theory vs. Business Practice: A Structural Tension

At the heart of the liquidity pricing debate lies a fundamental conflict between ALM objectives and business priorities.

From an ALM perspective, the goal is to establish a transparent pricing framework in which all risks are charged at their marginal market cost. This approach ensures that each business line is fully accountable for its profitability and that the balance sheet is managed efficiently. Subsidising loans with cheap deposits, from this viewpoint, obscures the real economic value of the deposit franchise and distorts incentives.

From the business perspective, however, the focus is on maintaining competitiveness in highly contested loan markets. Low-cost deposits are seen as a strategic advantage that should be leveraged to offer more attractive loan pricing. Fully charging marginal funding costs to lending products could make certain businesses unviable in practice.

In reality, many banks would struggle to remain profitable if all liquidity costs were fully passed on to products. As a result, liquidity pricing often becomes a negotiated outcome between ALM and business units, rather than a purely theoretical exercise.

Why Liquidity Pricing Is So Challenging Today

According to practical experience, two factors make liquidity pricing particularly complex.

The first is defining the right TLP proxy. Unlike other ALM areas, there is no single best-practice methodology for calculating the term liquidity premium. Banks use a variety of approaches, such as wholesale funding spreads, differences between asset swap spreads and CDS, primary versus secondary bond yields, or term swap versus OIS curves. Each method has advantages and limitations, forcing institutions to make judgment calls and justify their choices.

The second challenge is operationalisation. Implementing liquidity pricing through a Funds Transfer Pricing (FTP) framework requires a high level of granularity. It must account for self-funding features, contingent liquidity, behavioural maturities, collateralisation differences and changing market conditions — all at a product or even account level.

A Pragmatic Approach to Building the Term Liquidity Premium

Experience shows that a purely academic ALM approach often fails to meet the needs of banks operating in highly competitive markets. A more pragmatic solution is to construct the TLP curve using a blended approach.

This can include:

• Actual wholesale funding costs across tenors, based on real market quotes or peer proxies.

• A competitive adjustment reflecting the proportion of deposits in the bank’s funding mix.

• An incentive component linked to the NSFR, encouraging balance sheet optimisation by rewarding or penalising assets and liabilities depending on the bank’s structural funding position.

• Such an approach aligns risk management objectives with commercial realities, while still preserving transparency and discipline.

The Future of Liquidity Risk Pricing

Looking ahead, liquidity risk pricing will need to become more dynamic and responsive to market conditions, balance sheet structure and regulatory expectations. FTP remains the core tool for pricing liquidity risk and setting the right incentives across the organisation, but it must evolve beyond static models.

Integrating liquidity pricing with interest rate risk within a single platform, supported by next-generation calculation engines, will be critical. Granular, account-level FTP rates, calculated daily and embedded upstream in finance data architectures, can provide a single source of truth for Treasury, Finance, and business users alike.

Ultimately, effective liquidity pricing is not about choosing between theory and practice, but about finding the right balance between both — ensuring resilience, competitiveness and sustainable profitability in a changing financial landscape.