Question

1. Consider a bank that has the following assets and liabilities:

• Loans of $100 million with a realized rate of 5%
• Security holdings of $50 million earning 10% interest income
• Reserves of $10 million
• Savings accounts of $100 million interest of 2.5%
• Checking deposits of $30 million which pay no interest

1. Carefully explain what the impact would be on a bank’s ROA and ROE from increased use by a bank of off-balance sheet (OBS) activities.

Answer 1

Impact on a Commercial Bank’s ROA (Return on Assets) and ROE (Return on Equity) from increased used by a bank of Off-Balance Sheet (OBS) activities can be :

1. On Return on Assets Ratio using of Off-Balance Sheet Activities can be positive in financial performance if used within standards i.e. specific percentage of Assets in Off-Balance Sheet activities and volume should be high, if the volume of Off-Balance Sheet Item is low and percentage to Assets are high then Banks may incurr losses and ROA can be negative. Relatively, using of Off-Balance Sheet Items as compared to Balance Sheet Activities, ROA will be higher as the denominator of the formula (of ROA) will be lower in Off-Balance Sheet Activities and vice-versa.

2. On Return on Equity Ratio of a Commercial Bank ussing of Off-Balance Sheet Activities can be positive if used in standards and can also be negative if there is breach of Standards. Relatively, using of Off-Balance Sheet Items as compared to Balance Sheet Activities, ROE will have no impact as the formula (of ROE) is Profit After Tax / Shareholders Equity * 100. Using of Off-Balnce Sheet Items may increase profit rate but Financial Statements will be poorely presented.