Ready to supply the full 10 million at any time over

This preview shows page 11 - 13 out of 33 pages.

ready to supply the full $10 million at any time over the commitment period—for loan commitment Contractual commit- ment to loan to a firm a certain maximum amount at given inter- est rate terms. up-front fee The fee charged for making funds avail- able through a loan commitment. TABLE 2B–2 Off-Balance-Sheet Activities for Two Commercial Banks (in millions of dollars) Webster Financial* Bank of America* Commitments and Contingencies 1. Loan commitments 2. Commercial letters of credit 3. Standby letters of credit 4. Loans sold $4,951.74 19.31 168.62 $1,379,779.04 5,742.38 80,202.72 221,640.65 Notional Amounts for Derivatives 5. Forwards and futures 6. Options 7. Interest rate swaps 8. Credit derivatives 9. Total $536.92 385.37 878.97 $6,940.93 $3,612,974.43 4,621,577.39 20,536,696.59 1,266,040.23 $31,724,653.43 * Values are taken from the June 2007 FDIC Report of Condition data tapes available at the Federal Reserve Bank of Chicago Web site. Notional amounts reflect the face value of the contracts entered into.
Image of page 11

Subscribe to view the full document.

12 Appendix 2B Commercial Banks’ Financial Statements and Analysis example, one year. Meanwhile, the borrower has a valuable option to take down any amount between $0 and $10 million over the commitment period. The bank may also charge the borrower a commitment fee on any unused commitment bal- ances at the end of the period. In this example, if the borrower takes down only $8 million over the year and the fee on unused commitments is 1/4 percent, the bank generates additional revenue of 1/4 percent times $2 million, or $5,000. Note that only when the borrower actually draws on the commitment do the loans made under the commitment appear on the balance sheet. Thus, only when the $8 million loan is taken down exactly halfway through the one-year commit- ment period (i.e., six months later) does the balance sheet show the creation of a new $8 million loan. We illustrate the transaction in Figure 2B–1. When the $10 million commitment is made at time 0, nothing shows on the balance sheet. Nevertheless, the bank must stand ready to supply the full $10 million in loans on any day within the one-year commitment period—at time 0 a new contingent claim on the resources of the bank is created. At time 6 months, when the $8 mil- lion is drawn down, the balance sheet will reflect this as an $8 million loan. Commercial Letters of Credit and Standby Letters of Credit In selling commercial letters of credit (LCs—item 2 in Table 2B–2) and standby letters of credit (SLCs—item 3) for fees, banks add to their contingent future lia- bilities. Both LCs and SLCs are essentially guarantees to underwrite performance that a depository institution sells to the buyers of the guarantees (such as a cor- poration). In economic terms, the depository institution that sells LCs and SLCs is selling insurance against the frequency or severity of some particular future event occurring. Further, similar to the different lines of insurance sold by property- casualty insurers, LC and SLC contracts differ as to the severity and frequency of their risk exposures. We look next at the risk exposure from engaging in LC and SLC activities off the balance sheet.
Image of page 12
Image of page 13
You've reached the end of this preview.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern