When waves hit an obstacle, the incredible force of the backward movement, the
backwash, can leave even the strongest swimmers struggling. This potentially fatal current and interest rate risk have many points in common. And, if handled with skill, are not as dangerous as they seem.
We’ve tapped marine hydrology for 3 practical tips to help you manage your company’s interest rate risk – and maybe even bring you safely back to shore the next time you’re swimming off the Basque coast.
Secure tightly or drift?
Ray Dalio (one of the most well-known investors of modern times) believes that the monetary policies implemented by central banks since the 2008 financial crisis and their decisions to keep interest rates at rock bottom are not harmless: someone will be left holding the tab. And for good reason, the liquidity poured into the economy by central banks, rising debt levels and the formation of financial bubbles could well precipitate the end of the long-term credit cycle that started in 1945 at the end of World War II.
Having reached the “rate zero” bound, the downward wave in interest rates could suddenly crash back. And the violent backwash could take down the most vulnerable and least vigilant companies in its wake.
What can companies do to tame this interest rate risk? They can secure the ship tightly to the shore by fixing the interest rate on their debt, or they can decide to drift out a little further, if they are resilient and sound enough.
No matter what policy you set up to manage interest rate risk, the best practices below will help you to get the most out of your current position and the credit market.
#1 Have reliable data
Knowledge is power. Knowing what your resources are and the dangers prowling in your external environment will help you to accurately assess your current situation and risk exposure and avoid being caught off guard.
The first crucial step is to gather all the treasury data you need in a single and robust tool to measure your rate gap (the differences between floating-rate uses and sources of funds) with precision and assess the potential consequences of changes in these rates for both the income statement and balance sheets.
#2 Plan for more informed decision-making
Once you start to drift, it's too late to securely tie up. It's better to plan ahead instead of waiting until the last minute to react – and sometimes panic.
Make use of financial derivatives (swaps, forwards, forward-forward contracts, etc.) to fix your debt and neutralise the risk of fluctuations in interest rates. Do this early enough to avoid rushed decisions, reduce hedging costs and facilitate communication with all stakeholders.
Planning ahead calls for clear and transparent reporting, together with powerful and accurate simulation tools to run stress tests and assess the potential impacts of a range of rate scenarios on your financial ratios and covenants.
#3 Have the right tools
Everyone agrees that a wool sweater and boot filled with water are not the ideal swimming gear. Wearing a neoprene swimsuit is a much better idea.
Yet, despite the many efficient risk management solutions available, some finance departments are still using outdated tools that are simply not fit for the purpose of modern treasury management.
Why not make the most of the powerful features and automated functions of a treasury management solution to manage your interest risk efficiently and effectively? You will optimise risk management while eliminating the most painstaking and time-consuming tasks – freeing up valuable time for the most critical value-added jobs!