By: Alec Hollis & Michael Oravetz | CUNA Councils
While many industries use hedging strategies, not all hedging processes are alike. At the most basic level, hedging strategies can reduce or mitigate the detrimental impact of possible market variances. Many credit unions use hedging programs to control risk and manage the connection between profitability and risk. This article will examine why institutions decide to engage in hedging activities, as well as identify its various aspects.
Why Use a Hedging Strategy?
The changing regulatory and financial environments bring challenges to credit unions, and hedging programs should be included in a credit union’s risk-governance procedures. At the heart of effective risk management is the need to identify risk and institute sound policies, procedures, and mechanisms to manage an institution’s dynamic risk profile. Whether or not a credit union chooses to use hedging as a risk-management tool, that decision should be made within a risk-management framework after identifying and assessing the risk.
While credit unions decide to hedge for a variety of reasons, most fall into a few broad categories. The majority of credit unions’ business falls in the retail lending sectors, namely residential mortgage and consumer lending, and in retail savings and deposits. The decision to hedge is usually motivated by a desire to mitigate the interest-rate risk generated by one or more of these products and the relationship between them on the balance sheet.