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Off-balance sheet banking - Essay Example

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Over the last thirty years, there has been a scenario of increasing crisis while the banks have increased their portfolio of Off-Balance sheet activity through securitization, mainly short term asset backed by commercial paper. This has produced linkage between the banking system and the shadow-banking system. …
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Off-balance sheet banking
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Download file to see previous pages On the other hand, if the customer sells the investment and again deposits the amount in the Bank account, it becomes a liability for the bank. For instance, Citibank maintain an off-balance sheet asset of 960 billion $ which accounts for 6% of the GDP of United States. The formal distinction between On & Off-Balance sheets is quite critical and depends largely on the decisions of management. In true sense, a company would include assets and liabilities in their balance sheet if it either actually owns or for which it is legally responsible. For including an asset or liability in the Balance sheet, the asset or liability has to be probable, measurable as well as meaningful. Otherwise, the financial company or the Bank would treat the assets or liabilities as Off-balance sheet items. For example, a Bank which is facing a legal issue due to non-fulfilment of its liabilities would not include the amounts in its balance sheet until a complete judgment is received, until the amount of compensation or recovery is delivered through judgment, or may include the risk in its balance sheet if it is negligible until the entire legal process is over. Importance of controlling Off-Balance Sheet Banking and Role of Financial Regulators Over the last thirty years, there has been a scenario of increasing crisis while the banks have increased their portfolio of Off-Balance sheet activity through securitization, mainly short term asset backed by commercial paper. This has produced linkage between the banking system and the shadow-banking system. Thus, the importance of regulation off-balance sheet banking by financial regulators is a very...
Fall of Lehmann Brothers is an ideal example. Depositors not only withdrew money from their Bank accounts leading to sharp decline in deposit base of the banks but market investor also refused to invest in the share and stocks of the banks for which the share price of the banks fell steeply. This turmoil in the financial industry leads to increasing accountability for the financial regulators for controlling Off-Balance sheet banking.
Regulators control Off-balance sheet activity of Banks in order to safeguard their solvency and maintain the health of the national economy. Banks are expected to keep their Off-balance sheet assets and liabilities within a safe limit and also diversify the risk of Off-balance sheet activity. Banks are required to do a portfolio analysis of their borrowers through securitization and the offer financing to the selected parties in order to hedge the risk (Greuning and Bratanovic, 2009, p.48). Financing to a single large customer would affect the solvency of the bank based on the projected performance and repayment of a single party. On the other hand, diversifying the asset would reduce the risk the Off-Balance sheet risk. Banks are expected to look at the viability of settlement of funds before lending in Off-Balance sheet items. This would reduce the settlement risk of the Banks. Banks should look into comprehensive country risk in terms of irrevocable commitments, contingent liabilities and foreign-exchange positions to reduce off Balance sheet risk ...Download file to see next pagesRead More
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