Question

Give an example of an off-balance sheet activity for a commercial bank, along with its benefits and risks.

Answer 1

First to understand that Off balance sheet items are the asset and liabilities that are Not shown in the Bank's Books. Although these items are not mentioned in the books they are mentioned in the accompanying notes many a times.

One of the example of such item is Accounts Receivable. These are the accounts that have till date not paid their dues to the Banks. As there is a risk of default and these have to graded as Differnet assets and NPAs (Non performing assets) also, the bank can bundle these assets and sell them to a third party as Restructured Debt Instruments thus reducing the pressure on the balance sheet.

As and when these accounts pay up, the banks buys these assets back from the third entity in exchange of a service fee or collection fees and posts them into their books.

The advantage of this process is that the bank donot have to carry the risk of default in these assets and when it is collected can post them in their books.

The Risk is that if the loans really get bad, the bank ultimately has to take the hit in the balance sheet and the shareholders are generally not informed about these stressed assets as they were not recorded or recognised in the books.