Lecture 8 OBS Risk-1 - Lecture8 OffBalanceSheetRisk...

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McGraw-Hill/Irwin Lecture 8  Off-Balance-Sheet Risk Instructor: Lixiong Guo Semester 2, 2011
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Off-Balance-Sheet (OBS) Activities  § Financial guarantees Loan commitment Commercial letter of credit Standby letter of credit § Derivatives Forwards, futures, options and swaps Securitized assets When-issued trading Loans sold with recourse 8-2
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Off-Balance-Sheet (OBS) Items § In accounting terms Off-balance-sheet items usually appears “below  the bottom line”, frequently as footnotes to  financial statements. w Note: some derivative activities are reported on the  balance sheet. § In economic terms Off-balance-sheet items are contingent assets  and liabilities that affect the future, rather than  the current, shape of an FI’s balance sheet. 8-3
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Off-Balance-Sheet (OBS) Items They move onto the balance sheet when a  contingent event occurs.  OBS assets vs. OBS liabilities § A true picture of an FI’s economic solvency  should consider the market value of  both  on- balance-sheet and OBS activities. E = (A – L)+ (CA – CL) Large increases in OBS liabilities can render  an FI insolvent just as effectively as can on- balance-sheet activities. 8-4
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Off-balance-sheet items § In cash flow terms OBS assets or liabilities have the potential to  produce positive or negative  future  cash  flows. Fees from OBS activities provide a key source  of noninterest income for many FIs, especially  the largest and most creditworthy. 8-5
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Incentives to Increase OBS Activities § Losses on LDC loans and reduced  margins produced profit incentives Increases in fee income § Avoidance of regulatory costs or taxes Reserve requirements Deposit insurance premiums Capital adequacy requirements 8-6
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§ A contractual commitment to make a loan up to  a stated amount at a given interest rate in the  future. § Only when the borrower actually draws on the 
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Lecture 8 OBS Risk-1 - Lecture8 OffBalanceSheetRisk...

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