Hedge accounting for banks' interest rate risk

For most banks, hedge accounting is not about commodities or currencies but about the mismatch between fixed and floating rates across the whole balance sheet. This guide explains why banks hedge, how fair value and cash flow hedges remove accounting volatility, why many banks still use IAS 39 for macro hedging, and where ineffectiveness comes from.

By Hamza Fida, Chartered Accountant. Reviewed by Mirza Fahad Baig, Chartered Accountant. 3 minute read.

Short answer

Bank hedge accounting deals mainly with interest rate risk. Banks lend at fixed rates and borrow at floating rates, or the reverse, and use interest rate swaps to close the gap. Without hedge accounting, the swaps are measured at fair value through profit or loss while the loans stay at amortised cost, creating volatility that does not reflect the economics. Fair value hedges adjust the hedged loans for interest rate changes, and cash flow hedges defer swap gains and losses in equity. Many banks use the IAS 39 portfolio fair value hedge, which IFRS 9 still allows. In this guide's example, a 1% rate rise moves a 500 million mortgage book and its swaps by about 22.5 million each.

At a glance

Main risk
Interest rate risk
Typical instrument
Interest rate swaps
Fair value hedge
Adjusts the hedged loans
Cash flow hedge
Defers gains in equity
Macro hedging
IAS 39 portfolio hedge still allowed
Ineffectiveness
In profit or loss
Hedge accounting for banks' interest rate riskMain risk: Interest rate risk; Typical instrument: Interest rate swaps; Fair value hedge: Adjusts the hedged loans; Cash flow hedge: Defers gains in equity; Macro hedging: IAS 39 portfolio hedge still allowed; Ineffectiveness: In profit or loss.KEY FACTS AT A GLANCEHedge accounting for banks' interest rate riskMain riskInterest rate riskTypical instrumentInterest rate swapsFair value hedgeAdjusts the hedged loansCash flow hedgeDefers gains in equityMacro hedgingIAS 39 portfolio hedgestill allowedIneffectivenessIn profit or lossTax BakersHedge accounting for banks' interest rate riskMain risk: Interest rate risk; Typical instrument: Interest rate swaps; Fair value hedge: Adjusts the hedged loans; Cash flow hedge: Defers gains in equity; Macro hedging: IAS 39 portfolio hedge still allowed; Ineffectiveness: In profit or loss.KEY FACTS AT A GLANCEHedge accounting for banks'interest rate riskMain riskInterest rate riskTypical instrumentInterest rate swapsFair value hedgeAdjusts the hedged loansCash flow hedgeDefers gains in equityMacro hedgingIAS 39 portfolio hedge still allowedIneffectivenessIn profit or lossTax Bakers
Key facts at a glance, as set out in this guide.

Why do banks need hedge accounting?

A bank holds 500 million of five-year fixed-rate mortgages at 4%, funded by floating-rate deposits. If rates rise, its funding costs rise but its mortgage income does not. To protect its margin, it enters swaps to pay fixed and receive floating on 500 million. Economically the position is hedged. But the swaps are derivatives at fair value through profit or loss, while the mortgages are at amortised cost, so without hedge accounting every rate move shows up as profit or loss on the swaps alone.

What a 1% rate rise does with and without hedge accounting

Profit or loss effect of a 1% rate rise (CU million)Profit or loss effect of a 1% rate rise (CU million)2222Swaps0-22Mortgages220TotalWithout hedge accountingFair value hedge
Hedge accounting makes the accounts match the economics.
CU millionWithout hedge accountingFair value hedge accounting
Gain on swaps, at fair value+22.5+22.5
Change in fair value of mortgages for interest rate riskNot recognised-22.5
Effect on profit or loss+22.50, apart from ineffectiveness

The 22.5 million is estimated as 500 million x a duration of about 4.5 years x 1%. Under a fair value hedge, the mortgages' carrying amount is adjusted for the change in fair value due to the hedged risk, offsetting the swap. The adjustment is amortised to interest income over the mortgages' remaining life.

What is macro hedging and why do banks still use IAS 39?

A bank's mortgage book changes every day as loans are made and repaid, so hedging individual loans is impractical. IAS 39 allows a portfolio fair value hedge of interest rate risk, designating an amount of a portfolio in each repricing time band as hedged. IFRS 9 did not replace this: companies may continue to apply IAS 39's hedge accounting requirements, and most large banks do for their macro hedges, while the IASB develops a dynamic risk management model. The EU version of IAS 39 also includes a carve-out that allows demand deposits to be hedged in this way.

When do banks use cash flow hedges?

When they hedge variability in cash flows, such as floating-rate loans or forecast refinancing of deposits. A bank with floating-rate corporate loans that swaps them to fixed defers the swaps' effective gains and losses in the cash flow hedge reserve and releases them as the hedged interest affects profit. The reserve is excluded from regulatory capital. See regulatory capital vs IFRS equity.

Where does ineffectiveness come from?

  • Prepayments: mortgages repaid early leave swaps over-hedging the book.
  • Differences between the benchmark rate in the swap and the rate in the hedged item.
  • Credit and funding valuation adjustments on the swaps, which have no counterpart in the hedged loans.
  • Timing differences between swap payments and the hedged cash flows.

Ineffectiveness goes to profit or loss. Banks manage it by rebalancing hedges frequently, often monthly, as the portfolio changes.

What do banks disclose?

The swaps themselves are usually presented gross, even under netting agreements; see offsetting and netting. Banks disclose their risk management strategy for interest rate risk, the amounts of hedging instruments and hedged items, the hedge adjustments, the cash flow hedge reserve and ineffectiveness recognised, under IFRS 7's hedge accounting disclosures. See IFRS 9 hedge accounting and bank accounting.

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Questions people ask

Why do banks use hedge accounting?

To avoid profit or loss volatility from measuring interest rate swaps at fair value while the hedged loans and deposits are at amortised cost.

What is macro hedging?

Hedging interest rate risk on a changing portfolio, such as a mortgage book, rather than individual items, usually as an IAS 39 portfolio fair value hedge.

Can banks still apply IAS 39 hedge accounting?

Yes. IFRS 9 allows entities to continue applying IAS 39 hedge accounting, and most large banks do for macro hedges.

What causes hedge ineffectiveness for banks?

Prepayments, differences in benchmark rates, valuation adjustments on swaps and timing differences.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IFRS 9 Financial Instruments

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

IFRS 9Hedge accounting basics under IFRS 9BankingBank accounting: the key IFRS issuesBankingRegulatory capital vs IFRS equity

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This guide is general information. It is not tax or legal advice for your situation.