Question

2.

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

There have been various studies conducted to study the close impact on a banks ROE and ROA, where such banks have used the off-balance sheet method of finance for raising liquidity.

For explanation purposes, it can be said that, by obtaining liquidity using off balance sheet items, it saves itself by not allowing such financing to affect its existing debt burden. From various conclusions of various studies that I have read regarding such off balance sheet financing, in initial stages, such off balance sheet financing has a positivie effect on the financials of the bank, as it acts as a hidden capital, helping to generate more returns, and since returns increase, but neither do the assets nor equity increase correspondingly, the ratio is bound to be favourable. However, the moment a possible liability turns into an actual one, it could be the recipe for disaster. And it doesn't take much for a possible liability to become an actual one, it is like a risk that is waiting to become true. And once it happens, all ratios including ROE, ROA, etc are gone for an absolute toss. Certain steps such as setting up cieling limits, framework by regulators including those of disclosures as well, are some ways through which precaution can be exercised by banks as well as other stakeholders.

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