Managing interest rate and liquidity risk

| 06-09-2016 | Rob Söentken |



Funding is one of the key focus areas of a treasurer. There are numerous dimensions to funding:
1. Assessing amount and timing of cashflows
2. Arranging access to funding
3. Developing and implementing hedging policy
4. Optimizing funding cost and risk

Assessing amount and timing of cashflows

Assessing the amount and timing of cashflows is a continuous process. Because needs can change both in short and long term.

Arranging access to funding

Matching funding needs with supply from financial institutions is also a continuous process. The typical approach would be to match tenors, but immediate access to cash is critical for the survival of any entity. It could be considered to arrange longer term financing, even for short term (revolving) funding needs. The downside is that long term access is more expensive than short term access. This may be acceptable, but if the spread between borrowing and lending excess cash is too wide, it will become very unattractive to borrow for long tenors.

Developing and implementing hedging policy

To ensure the treasurer works within the boundaries of his mandate, he has to develop a hedging policy which must be documented (‘on paper’) and approved by his management. The document should describe the whole area of funding, to ensure both the creation and hedging of risks are described.

Optimizing funding cost and risk

The main focus drifts towards reducing funding cost. The funding market typically has a steep cost curve, meaning that rates are higher for longer tenors. This results from a steep ‘risk free’ curve and / or from a steep ‘credit spread’ curve. Which often brings entities to borrow for the cheapest tenor possible, being monthly, weekly or even overnight funding. Funding for very short tenors creates the considerable risk that can cause a company to run into a liquidity crisis, in case access to funding disappears. How to deal with this dilemma?

The best approach is to define a number of scenarios to assess the impact of combinations of financing and hedging on funding and risk. A base scenario could be to finance all funding needs using overnight loans. In case of liquidity problems, what would be the impact on the funding rates? Another scenario would be using quarterly funding or yearly rollover funding, potentially combined with:

  • money market futures
  • interest rate swaps
  • caps / floors
  • bond futures or even
  • credit derivatives

What are the incremental funding cost? What are incremental operational expenses of running various products? Can the entity deal with managing margin requirements? Is the entity aware of the basis risks involved when using credit derivatives, which are fairly complex products?

Rob Soentken



Rob Söentken

Ex-derivatives trader


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