Chapter 16 Flashcards
What are off-balance sheet assets?
It is when a contingent event occurs, it moves the asset onto to the balance sheet
What is off-balance sheet liability? Give an example
It is when a contingent event occurs, it moves the liab onto to the balance sheet
Ex: Line of credit
What is makes an item an on balance or off balance sheet item
It is CONTINGENT event, something triggers an event
What are the 4 securities held off balance sheet
1) forward contract
2) futures contract
3) options
4) swap
Why do banks do off balance sheet liabilities?
Because it is a great source of income
What are the 3 activities of the off balance sheet is the government interested/look into?
1) Reserve requirements
2) Deposit insurance premiums
3) Capital adequacy requirements
What are the 5 major types of off balance sheet activities for U.S. banks?
1) loan commitments
2) letter of credit
3) Futures, forward contracts, swaps and options
4) When issued securities
5) Loans sold
Describe the procedure of a letter of credit
The bank takes the money out of the buyers account and puts it into a “suspense account. This is a contingent activity based on the goods being delivered. From there, once the delivery of the good is made, the seller will call the bank to collect their money
Why is the letter of credit a liability for the bank?
Because it is a deposit even when it is in the “suspense account”
How is the fee for the letter of credit set?
It is a percentage of the dollar value of the letter of credit
(ex: 3% of the $3 million letter of credit)
What is takedown risk? Give an example and explain where the money goes once it is borrowed or not borrowed
Amount of money borrowed from the total that has been approved.
(Ex: borrowed $300k of the total $700k approved). Once this money is borrowed, it is an on balance sheet assets and if it is not borrowed, it is an off balance sheet liability
What is important to know about credit risk with regards to takedown risk from when it was approved compared to when it was borrowed?
The credit risk is not necessarily the same from when it was approved to when it was borrowed. Sometimes the economic conditions change which may be the reason for increased credit risk and increased borrowing (takedown risk)
What is recourse? Give an example?
Recourse is the ability to put an asset or loan back to the seller if the credit quality of that asset goes back. Think of mortgage backed securities
(Ex: in the contract for a mortgage, it states that you cannot miss more than 3 payments. Therefore, if the borrower or mortgage payer misses 4 payments, the issuer has the right of recourse which means they can go take back the house and so on)
What is no recourse?
Means that if the FI sells an asset that goes bad, the buyer takes all the risk, can’t go back after them
What is settlement risk? Give an example
It is the risk of the money not making it to where it has been transferred
(Ex: If bank A wants to transfer money to Bank B but bank A goes bankrupt as the payment is going through, the payment might get cancelled since the creditors of bank A will want money that is owed to them)
