The Uncalculated Risk of Currency

It’s clear the world is in period of instability. With the ongoing effects of the global pandemic, the Russian invasion of Ukraine and the degrading health of the planet, we face tremendous uncertainty. As a community bank, your clients look to you for tools to navigate change and create as much stability as possible. That’s why we want you to better understand how foreign exchange and hedging can help to protect you and your clients.

You may be of the view that foreign exchange is a fringe service for a community bank or credit union, more the domain of the big banks. But any company of any size that conducts cross-border business can get crucial advantages from using foreign currencies. If you serve small and medium-sized businesses, and individuals that invest abroad, then foreign exchange and hedging are tools that are fundamental protective services. This is truer now than ever since we’re in a time of continual black swan events.

Black swan events, as you know, are those unexpected and unwanted moments that create chaos. They can be big or small, but when they happen, they send the financial industry, business owners and everyday people scrambling for cover. At a personal level, a black swan event might be having your identity stolen or being the victim of financial fraud. On a business level, it might be losing a significant contract or a valued senior manager. At a global level, well, as already mentioned, we’re experiencing several in tandem right now, including climate change.

When you conduct business or invest abroad, you’re at higher risk for a black swan event. Why? You’re more directly affected by geopolitical events. Your financial situation is influenced not only by what happens in your local community, but all the places you’re doing business. And, very importantly, you’re affected by the currency fluctuations of those countries – even if you pay for goods and services in U.S. dollars. In fact, especially if you pay in U.S. dollars. Yes, you read that right.

Most Americans think they are unaffected by currency fluctuations because the U.S. dollar is the world’s go-to currency. As a strong, stable currency, we tend to think currency worries are for other people. But currencies fluctuate constantly, especially in a fast-changing era like we’re in now. And those fluctuations can affect what you pay for foreign goods, services, stocks and mutual funds. Again…especially when you pay in U.S. dollars.

Let’s say one of your small business clients wins a huge contract in Mexico and secures suppliers there to help fulfill it. Then let’s say, the Mexican peso shoots up in value and the cost of that project climbs 15%, wiping out your client’s profit margin. This is a business-level black swan event, and the repercussions can be massive. This may drain the company’s cash flow, working capital and equity position. If they have a loan with you, you may have to recall it based on debt covenants. A single occurrence like this could spell the end of a small or medium-sized company. But all of this can be avoided if your clients pay foreign invoices in foreign currencies and use hedging.

How can this be? If that same small business secured a rate to buy Mexican peso at the start of the project, when the currency skyrocketed, they would have been unaffected. They would have paid the locked-in rate, and the cost of their project would have remained unchanged. That’s the powerful benefit of foreign exchange hedging.

Foreign exchange hedging is simple, effective, and essential when the world is in a constant state of uncertainty. Companies all around the world use hedging to project themselves from currency fluctuations, but American businesses have been very slow to adopt the strategy, preferring to always pay in U.S. dollars.

Many Americans don’t fully recognize the risk of conducting business and investing abroad in U.S. dollars. But the essential point to make here is that when you use U.S. dollars, you can’t use foreign exchange hedging. You’re entirely exposed to any currency fluctuation that may happen. As a bank or credit union, you’re in an ideal position to help your clients understand the risk and protect themselves. You can help them overcome their fear or avoidance of common-sense tools like foreign exchange hedging.

Hedging may sound like a complicated financial strategy only for major companies that conduct huge transactions abroad. This is not the case. Hedging is like buying insurance on your home or business. It’s protection for foreign payments and investments. Anyone can – and should – do it.

Hedging has been shown to increase market valuation by 4.87 percent (in a study by Allayannis and Weston, The Use of Foreign Currency Derivatives and Firm Market Value). It’s been demonstrated that it lowers cash flow volatility, in a 5-year study by Bartram, Brown and Conrad of 6,000 companies from 47 countries.

We understand you may not have the time or inclination to dive deeply into the topic of foreign exchange. That’s why a partnership with Western Union Business Solution is so strategic. You can go head-to-head with industry giants, but with the added value of your more personalized, local approach. You don’t need to become a foreign exchange guru. You just need to partner with one.