OFF BALANCE SHEET

ACTIVITIES
Loan
Sales

Fee Income
Trust
Accounts
Letter of
Credit

Off-balance-sheet activities involve trading

financial instruments and generating income
from fees and loan sales, activities that affect
bank profits but do not appear on bank
balance sheets.

 In many cases they also involve the creation

of contingent claims against the banks,
hence they are also called contingent
accounts.

Involves a contract
that sells all or part of
the cash stream from
a specific loan and
thereby removes the
loan from the banks
balance sheet.

LOAN
SALES

Banks earn profits by

selling loans for an
amount
slightly
greater
than
the
amount of the original
loan.

GENERATION OF FEE
INCOME

Involves the generation of income from fees

that banks receive for providing specialized
services to their customers.

LOAN COMMITMENT

OVERDRAFT PRIVILEGES

For a fee, the bank agrees to provide a

loan at the customers request, up to a
given dollar amount, over a specified
period of time.

These bank customers can write

checks in excess of their deposit
balances and, in effect, write
themselves a loan.

TYPES OF BACKUP LINES OF

CREDIT
STANDBY LETTERS OF
CREDIT
To back up issues of
commercial paper

Other securities and credit

lines for underwriting
Euronotes.

EXPOSURE TO RISK
Off-balance-sheet
activities
involving
guarantees
of
securities and backup
credit lines increase
the risk a bank faces.

 EvenEXPOSURE
though
a
TO
guaranteed security
does not appear on a
bank balance sheet,
it still exposes the
bank to default risk: If
the issuer of the
security defaults, the
bank is left holding
the bag and must pay
off
the
securitys
owner.

RISK

EXPOSURE TO RISK

Backup credit lines

also expose the bank
to risk because the
bank may be forced
to provide loans when
it does not have
sufficient liquidity or
when the borrower is
a very poor credit
risk.

10

TRADING
ACTIVITIES
Trading activities, although often highly
profitable, are dangerous because they make
it easy for financial institutions and their
employees to make huge bets quickly.
A particular problem for management of
trading activities is that the principal-agent
problem is especially severe.

PRINCIPALAGENT
PROBLEM

Given the ability to place large bets, a

trader (the agent), whether she
trades in bond markets, in foreign
exchange markets or in financial
derivatives, has an incentive to take
on excessive risks:
If her trading strategy leads to
large profits
She is likely to receive a high
salary and bonuses

PRINCIPALAGENT
PROBLEM

But if she takes large

losses,
the
financial
institution (the principal)
will have to cover them

13

HOW TO REDUCE PRINCIPAL-AGENT

PROBLEM

Managers of financial
institutions must set
up internal controls to
prevent debacles
Managers must also
scrutinize risk
assessment procedures
using the latest
computer technology

Managers must set

limits on the total
amount of traders
transactions and on
the institutions risk
exposure

OFF

Balance Sheet
Activities of
Commercial
Banks in the
Philippines

Off balance sheet

banking in the
Philippines is not a new
phenomena.
Central bank policies
on off balance sheet
activities are noted to
have been issued as
early as 1959.

Off Balance Sheet Activities of commercial

banks in the Philippines may be grouped
into four:

16

Payments and
Fiduciary
Trade related
Investment
accounts
guarantees and operations which banking related safekeeping
which consists of bill
refer
to
the
banks
foreign
accounts.
for collection other
trust accounts
exchange
than those
and managed
administered by the
services.

funds.

trust department.

TRUST
ACCOUNTS
Under trust, the trustee has the general
authority and responsibility to administer
and manage trust account.
The bank itself formulates policies regarding
the investment and disposition of funds
subject to restrictions provided in the
agreement.

TRUST
ACCOUNTS
Trust accounts are also suspected of being
increasingly used to engage in normal
banking activities on an off balance sheet
basis.

O1

It provides banks a way

of avoiding regulations
related to reserve
requirements and bank
capital adequacy
requirements.

O2

O3

Off balance sheet

Non-regulatory factors
may also have provide activities are not reflected
in the regulatory
incentives for banks to
definitions of capital
diversify their loan and
adequacy which makes
investment portfolio.
the interpretation of
banks exposure to
particular risk less clear.

ISSUES ON OFF BALANCE SHEET ACTIVITIES