Interest Rates

A Framework for Interest Rate Risk Management

Banks are often unknowingly exposed to risk due to balance sheet structure, and they often seek to change that composition through pricing and customer incentives. While this approach can be effective, it takes a long time and tends to be costly.

The key to avoiding this risk is to accurately quantify your exposure to interest rate movements.

  • Determine your strategy: Specify your risk appetite in relation to your annual objectives. What limits exist and what is their impact on your net interest income? Map the relevant policy statements to OCC-defined risk categories, and develop procedures to implement the policy statements.
     
  • Measure and monitor: Measure interest rate sensitivity and analyze potential hedge structures to move towards your objective.
     
  • Implement and execute: Recommend potential hedge structures and strategies. Simplify needless complexity, and compare the impact of alternate hedging strategies on net interest income.
     
  • Evaluate and assess: Address the regulatory, governance, credit accounting, and educational requirements of each recommendation and create a plan to execute.

By using these strategies, Grayline can optimize you institution’s unique objectives and constraints relative to profitability, liquidity, cash flow and income at risk, as well as operational, regulatory, and accounting considerations. A successful framework for interest rate risk management must combine leading practices with regulatory and accounting guidance, with specific attention paid to an institution’s unique risk appetite and strategic objectives.

To learn more about how Grayline can help with managing interest rate risk, contact us.

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How Smart Companies Prepare for Rising Rates

With every anticipated interest rate adjustment, we notice an increase of jitters among our clients. If the Fed raises interest rates, will that put a drag on GDP growth or even crush it altogether? They could opt to wait, but such a holding pattern seems unlikely as it could lead to inflation with easy money and “runaway” expansion.

In one article, "What to Expect as the Federal Reserve Decision Nears," author Jeffrey Moore asks the burning question: which way will the Fed lean in order to do the “wrong” thing?

The implications for global business are huge. An increased demand for the greenback will widen the already appreciable gap between the USD and other currencies. As other currencies continue to weaken, this will threaten the earnings of domestic companies generating business abroad.

But before the dust settles, smart companies must decide how to position themselves for rising rates. It’s a matter of when, not if.

How Smart Managers and Board Members Respond to a Potential Interest Rate Hike

“Smart” companies—no matter what size—are doing at least three things to prepare. They always have, to varying degrees. But now they’re doing them with stepped-up urgency and energy:

  • Evaluate their company’s debt service and capital structure
  • Optimize capital structure around goals and limits
  • Take action early

Smart companies also respond to events in the economy by continually reevaluating their position in light of new information. They ask key questions early — and often.

  • How is my company servicing its debt today?
  • What portion is fixed or floating?
  • Will that change if we do nothing? Are there covenants that may take effect under certain conditions? Will those conditions get triggered in a rising rate environment?
  • What about my company’s debt/equity mix?
  • Have I considered financial instruments that may improve the capital structure?

And smart companies don’t wait until all of the uncertainty is taken out of the equation (that is, after rates rise or after the dollar strengthens or weakens). They know that by then, it’s too late. Instead, they assess their current position, determine the optimal positioning, and act early. Smart companies build risk management into their operations, and the process of assessing, optimizing, and acting is ingrained in the company’s DNA.

The Benefits of a Good Assessment

After assessing its strengths and vulnerabilities, a company must determine the optimal positioning to benefit from (or avoid the downside of) potential events. If the economic context never changed, companies would never need to adjust their balance sheets or capital structure. It is precisely because economic conditions are uncertain–and constantly in flux–that smart companies position themselves to benefit optimally.

Nobody knows exactly what will happen, but every company can be prepared for changes in the economy whether or not they’ve forecast correctly.


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