I Hedged My Balance Sheet for the First Time in 2023. Now What? HEDGING BEST PRACTICES FOR FINANCIAL INSTITUTIONS By Ben Lewis, Managing Director and Head of Sales, Chatham Financial 2023 was a wild ride. Many banks came under stress after 500 basis points of rate increases. Investors and depositors worried about unrealized losses and withdrew their capital and liquidity, leading to a small number that failed. Management teams reacted quickly and began hedging their balance sheets. For many banks, maybe yours included, it was the first time using derivatives. You may be asking yourself, what now? How do I optimize this solution now that I have it? What are best practices? 1. Strategic tool vs. last resort. Some bankers employed derivatives because they felt compelled to hedge and are hoping they won’t need to do it again. That mentality misses the strategic tool that derivatives are for balance sheets and customers. Derivatives allow banks to optimize customer requests, investment decisions and funding choices. In some cases, they provide significant cost savings or bring forward future income. In other cases, they allow leadership to meet market demands without taking interest rate risk. 2. Hedging vs. trading. Well-meaning brokers may suggest a derivative because it is a good “trade” that may “make” money for the bank but exacerbate its risk to rising or falling rates. The best practice considers derivatives as hedges, not trades — risk management, not investment. In application, this means starting from the balance sheet: what is the risk position? Where is it trending? Would a derivative help change that direction? And lastly, best practice measures the proposed transaction’s impact on earnings in different rate environments before executing. 3. Proactive vs. reactionary. Sometimes, when a balance sheet’s risk position is lopsided, management turns to derivatives to bring the balance back. But derivatives are not a silver bullet. Colorado Banker 18
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