Hedging Deposits to Reduce Liability Sensitivity

A Chatham Financial White Paper – April 2015

 

Chatham has long espoused POLAR (the Path Of Least Accounting Resistance) when it comes to balance sheet risk management. There is a bias towards simplicity and operating in the cash flow hedge accounting model whenever possible, in order to minimize or even eliminate hedge ineffectiveness and P&L volatility. For a liability sensitive FI, reducing asset duration or extending liability duration, or both, can have the desired impact on the FI’s interest rate risk position. Once a financial institution decides it will use derivatives to make these adjustments, the question of what to hedge takes center stage.

This white paper focuses on increasing liability duration (and thus reducing liability sensitivity) by hedging deposit accounts. Of course we apply our POLAR methodology to determine the simplest and most effective economic and accounting solution.

 
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