By Emily Hollis, CFA
It is official: the use of derivatives is permissible under NCUA regulations.
The NCUA listened to responses and altered the restrictions that would have severely limited the impact of derivative use. The most significant changes in the new ruling are altering notional amounts so they are now based more on duration and extending maturity limits. Eliminating the entrance fee was also a very prudent move.
So, why would credit unions need derivatives?
Generally, institutions generate income by exposing their balance sheets to different types of risks—interest rate, convexity, and liquidity—and through financial intermediation (gathering a portfolio of member deposits and building a portfolio of member loans). Understanding and applying strategies for managing these risks and strategies for balance sheet construction can enhance returns, but they also present risks if interest rates rise or liquidity spreads widen.
