The Importance Of Interest Rates In Organizations

Interest rates are an area of extreme risk if not managed properly. A risk to organizations is legislation set by the European Union, the legislation itself is not the risk but rather the effect it has on different industries and on the level of impact it has on different organizations. Industries that have high cash volume must manage their deposits in order to get the best return. Also organizations with high debt capital must be wary or the interest rate they are paying and if it is sustainable. An easy way of testing if the rate of interest a company is paying is the interest cover formula which is net profit before interest divided by interest paid, this fundamentally gives how many times the companies’ profits can cover the interest

The three federal banking agencies are the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency and they believe that effective interest rates are essential to providing a safe and reliable service to their customers. These agencies belief that because of market conditions, bank structures, and bank activity variance, each bank needs to develop its own interest rate risk management program tailored to its needs and circumstances. Nonetheless, there are certain elements that are fundamental to sound interest rate risk management, including appropriate board and senior management oversight and a comprehensive risk management process that effectively identifies, measures, monitors and controls risk. The agencies have advised financial services to take a prudent approach in their principles and practices in order to reduce risk and stating that it will also allow the services to better identify, evaluate and effectively deal with

Companies must use a flexible risk management process in order to sustainably manage risk in such a fluctuating area such as interest rates. Changes in legislation from the EU can be harmful to a financial services strategic plan, causing it to become unpredictable. Any change in legislation related to interest rates can have a big impact on a company’s risk management process. The unpredictable nature of interest rates is what makes it such a risky area, and that in itself causes more risk due to the fact that the riskier a company the higher the interest on lending to it, therefore by a company identifying interest rates as a risk it incurs more interest on its loans. In order to combat this problem efficiently and flexible risk management procedures of interest rates must be practiced. The most effective way I have found in doing so from my study of the area is by having a comprehensive understanding on the driving factors of interest rates, one of these key factors being legislation. To stay on top of this a company should follow EU directives closely in order to be prepared for any changes they may come about without being caught unawares.

My conclusion in relation the risk management of interest rates related to legislation is that legislation is easily predicted if the company stays focused and tuned in to the happenings in European or domestic economy. In relation