5 minute read 28 Mar 2024
Hedge accounting

Hedge accounting across banks: key challenges and perspectives

Shiva Iyer
By Shiva Iyer

EY India Financial Accounting Advisory Services (FAAS) Partner

Helping clients embrace digital disruptions and drive change in the finance, regulatory and treasury functions. Financial services advisor and strategist. An avid sports enthusiast and career coach.

5 minute read 28 Mar 2024
Related topics Financial accounting advisory services CFO agenda
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  • Navigating the complexities of hedge accounting for banks

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Volatility in interest rates due to external factors poses a considerable challenge to banks in designing micro and macro hedging strategies.

In brief 

  • Balance sheet management on account of interest rate fluctuations based on central bank policies and global macro-economic events is a must to adapt to the dynamic changing conditions.
  • This is where hedge management and hedge accounting comes into play. The aim is to create a balance that will help reduce the potential for financial loss in unpredictable market conditions.
  • The challenges faced by banks on account of adverse movements in interest rates, Fx and commodities etc. can be overcome by having a robust hedging strategy in place that ultimately helps optimize returns in a volatile environment while conforming to regulatory standards.

Interest rate volatility can greatly impact the profitability and overall financial health of banks. To safeguard against adverse rate movements, banks employ hedging strategies. These strategies involve the use of derivative instruments, such as interest rate swaps, currency swaps, options, and futures, to offset potential losses and manage risk exposures.

However, managing interest rate risk goes beyond simply implementing hedging techniques. It requires a structured approach, and this is where hedge accounting steps in. Hedge accounting plays a vital role in providing transparency and accuracy in financial reporting for banks.

Volatility in interest rates presents a significant challenge for banks in the current landscape. The application of hedging strategies and hedge accounting is crucial in mitigating risks and striving for financial stability. By implementing robust processes tailored to their specific needs and leveraging technology solutions, banks can proactively overcome complex hedge accounting challenges and effectively navigate the fluctuations in interest rates.
Adarsh Ranka
Financial Accounting Advisory Services Leader, Partner with an Indian member firm of EY Global

While hedge accounting challenges are prevalent, it is essential to address them to enhance the overall effectiveness of risk management strategies. Additionally, improving hedge accounting efficiency is crucial for banks to streamline their processes and ensure compliance with regulatory requirements.

There is clearly a growing demand across financial services firms both globally and in India to undertake hedge accounting to mitigate the significant rise in interest rates on the back of exceptional monetary easing done by central banks due to COVID-19. Some of the typical hedge accounting challenges faced by financial services firms relate to financial reporting disclosures and legacy IT systems, processes and controls. Overcoming these challenges requires the adoption of hedge accounting best practices, including standardized hedge documentation, robust software that addresses hedge effectiveness, and regular monitoring and handshakes between the risk, treasury and finance teams.
Shiva Iyer
EY India Financial Accounting Advisory Services, Partner with the Financial Services practice of FAAS

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How EY can help

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Summary

Hedging demands a deep understanding of financial markets and derivative instruments, as well as a careful evaluation of potential risks and benefits. Thus, it is crucial to consult with relevant experts when implementing hedging strategies. In an ever-evolving financial landscape, hedging continues to play a pivotal role in safeguarding financial interests and maintaining economic stability.

About this article

Shiva Iyer
By Shiva Iyer

EY India Financial Accounting Advisory Services (FAAS) Partner

Helping clients embrace digital disruptions and drive change in the finance, regulatory and treasury functions. Financial services advisor and strategist. An avid sports enthusiast and career coach.

Related topics Financial accounting advisory services CFO agenda
Upvote