A Strong Hedging Strategy is a Difference-Maker for Banks

Time is a flat circle, as they say. Everything that has happened in banking will eventually happen again. Risk follows us wherever we go, like a passenger in a car. Most of the time, the risks we worry about are safely stored away, conveniently out of sight and out of mind. Other times, the risk makes its way to the front seat, distracting the driver, shifting focus and altering priorities. In the worst of times, the passenger pushes the car off course entirely.

Nobody can reliably forecast the next big disruption. Even the best offense needs a strong defense to outperform in the long run.

Learning From the Last Five Years
What can bank management teams and directors learn from the last five years, a period that whipsawed us between a global pandemic, emergency rate cuts, a 500-basis-point spike in rates cycle and bank failures? With the benefit of hindsight, it is easy to observe the banks that hedged successfully against rising and falling rates.

However, what made these decisions successful wasn’t a brilliant market call; it was discipline. It was a long-term mindset that looked further into the future than others.

The last few years of bank call reports, supplemented with public disclosures around hedging strategies, offer valuable insights into creating and maintaining long-term shareholder value. The question for today’s management teams and directors is this: Will your bank maintain its discipline moving forward?

Hedging Can Keep Us on Track: Investors Value Consistency
Over the past two years, a surge in hedging activity was influenced, at least in part, by the magnitude of the inverted swap curve — where short-term rates exceeded long-term rates. This unique market environment let banks mitigate a negatively gapped balance sheet while benefiting from current period earnings, and many took advantage. It is not often that we are paid to buy the insurance needed to manage risk. Decisions about future hedging strategies, however, will likely involve more difficult trade-offs.

It’s worth noting that banks with disclosed hedging activity had a smaller variance in their net interest margin over the last five years compared to those without.

Consistent earnings performance across changing economic environments requires a balanced risk posture. Of course, achieving this is easier said than done, as hedging often means saving a dollar today for tomorrow’s benefit.

Simple hedging strategies — such as locking in funding spreads or using pay-fixed swaps to manage asset duration — can protect banks from spikes in liability costs while balancing risk across the institution.

Hedging Supports Healthy Loan Growth: Intelligent Growth Drives Value
Banks with hedging programs had better loan growth, taking market share from less-nimble competitors. High-performing banks often offer hedging products to commercial borrowers, providing the most competitive pricing for predictable debt service costs. The bank generates fees from facilitating capital market transactions while maintaining the flexibility of floating-rate assets to balance its asset/liability mix.

For borrowers, the outcome is equally advantageous: Locking in a lower, fixed rate compared to alternative fixed-rate balance sheet lending products.

Managing Risk Well Positions You to Grow When Others Falter
Banks with hedging programs tended to have greater capital and strategic options than those without. Perhaps the most compelling case for maintaining a balanced risk posture is the flexibility it provides during uncertainty. Whether navigating unforeseen challenges or capitalizing on periods of industry consolidation, banks with a proactive strategy are well-positioned to take advantage of opportunities while competitors remain on the back foot.

Unlike other, more straightforward asset and liability management benefits of hedging, being in the driver’s seat can create a positive change in institutional value, especially during turbulent periods when strategic moves matter most.

The Path Forward
Managing risk today isn’t just about weathering the next rate cycle. It’s about building a foundation for consistent performance, healthy growth and long-term success, no matter what surprises lie ahead.

Successfully navigating complex market dynamics requires both discipline and expertise. An experienced advisor can help bank leaders identify opportunities, assess trade-offs and build tailored hedging strategies that align with long-term goals. By partnering with experts who understand both the risks and the tools available, banks can position themselves to make proactive, informed decisions, strengthening their resilience and competitive advantage.

In an unpredictable world, sound guidance and a balanced approach ensure that risks remain passengers, not drivers.