Should Derivatives Be Allowed?

The NCUA has been requesting comments on a proposal to permit credit unions to engage in certain derivative activities. Now that the agency has closed the comment period and is reviewing those letters, it’s important to keep a few key points in mind when asking, should credit unions be able to invest in derivatives after the losses of the past few years?

Hedging is insurance. Insurance can be costly and should be understood as such–not as losses. It’s critical for credit unions to manage their balance sheets to generate income, ensuring financial stability. Generally, this can be performed by duration mismatch and convexity risks within the balance sheet, which can generate short-term increases in income. But it certainly comes with a higher likelihood of future loss. On the other hand, the conservative practice of selling mortgage loans and avoiding other longer duration asset classes can be equally devastating if rates remain low for an extended time.