Five Signs That a Financial Institution is Not Hedging its Interest Rate Risk
Minneapolis, MN | May 9, 2024 | By: John Trefethen, Director and Co-Founder
What follows are five signs that a financial institution is not hedging its interest rate risk.
Interest rate sensitivity. If a financial institution’s financial statements show significant fluctuations in net interest income or net interest margin in response to changes in interest rates, it suggests inadequate hedging.
Duration mismatch. A financial institution that has longer-term assets funded by shorter-term liabilities – or vice versa – without appropriate hedging instruments in place is vulnerable to interest rate risk.
Lack of derivative usage. If a financial institution isn’t actively engaging in interest rate derivative transactions or has minimal exposure to such instruments, it may indicate a lack of hedging strategy.
Asset-Liability management oversight. If a financial institution doesn’t consistently perform stress testing, scenario analysis, or dynamic balance sheet simulations to evaluate its interest rate risk exposure, it may not have the insight necessary to recognize that it may not be adequately hedged.
Volatility in earnings. If earnings fluctuate widely due to changes in interest rates, it likely indicates a lack of interest rate risk management strategy.
These five signs don’t necessarily mean a financial institution isn’t hedging at all, but rather may indicate that their hedging strategies are inadequate or insufficiently implemented.
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Author: John Trefethen, Director and Co-Founder
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