How does off balance sheet item affect Balance Sheet? Justify with examples : Banking Tayaari

 

How does off balance sheet item affect Balance Sheet? Justify with examples. 

Ans :- Off Balance Sheet (Off B/S) transactions are those in which there is a possibility of incurring liabilities in the future. Such transactions include letters of credit (L/C), securities, letters of acceptance, commitments, foreign exchange related swaps, options, advance transactions, etc.

These transactions can affect balance sheet in the following ways:

• Bank gets fee based commission income from transactions like L/C, bank guarantee which goes to the reserve fund of the balance sheet through profit and loss account (P/LA / c).

• The bank earns trading income from foreign exchange transactions such as swaps, options, forwards, etc. and it is also is eventually added to the reserve fund through P/L A/c.

• As such transactions carry a contingent liability, if the bank has to make cash payments in the future, the cash assets of the bank will decrease. 

• In transactions such as L/C, bank guarantee, if the customer does not fulfill the contract or fails in repayment, the bank has to account for them as a force loan.

• In some L/C, banks require a cash margin upto 100% for which term deposits are opened and pledged. This increases the deposit liability of bank.

• Trust Receipt Loan in some L/C transaction will increase loan of banks.

• When calculating the capital adequacy ratio, risk weight is calculated on Off B/S transactions. If the quality of such transactions is low and the risk weight is high, NRB may impose various actions and fines on the bank as the capital adequacy ratio can decrease below the limit, which may shrink transaction and affect B/S.

• If bank does not pay timely on liability arised to third parties due to the negligence of the customer, various fines will be levied, which will affect the B/S.

• If bank does not show efficiency in such transactions, the reputation of the bank may also be negatively affected, as a result of which the overall B/S size will also be affected.

In conclusion, there are various risks involved in Off B/S transactions, even though it is a very lucrative business for the bank. The positive development of such transactions has a positive impact on income & negative development attract fines, penalties, etc. which ultimately affect B/S either positive or negative respectively.