The number of banks using derivatives to manage interest rate risk could increase significantly as a result of a new hedge accounting standard issued by the Financial Accounting Standards Board today. The standard — which reduces many of the operational burdens banks currently experience with hedge accounting — becomes effective in 2019 for public business entities, though early adoption is permitted.
In addition to significantly expanding the interest rate indices that can be hedged, the standard eases certain requirements for the hedging of specific risk components. It also introduces a “last of layer” concept that requires significantly less documentation outside a bank’s normal asset-liability management process. The “last of layer” option — which is used when hedging the impact of interest rate changes to pre-payable mortgage portfolios — was developed through consultation with ABA member banks of all sizes.
Feedback from community bankers on this aspect of the standard has been notably positive; some indicated that it could help their efforts to control financial statement volatility, while others noted that, given the ease of the approach, they might consider using derivatives for the first time in order to control interest rate risk. For more information, contact ABA’s Mike Gullette.