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OFF-BALANCE SHEET ACTIVITIES IN INDIAN BANKS. BANKING SECTOR. Banking sector plays an important role in the economy of a country. It supplies the life-blood-money that supports and foster growth in any economy. Primary function of Banks. Banks. Lending (asset). Accept deposits (liability).
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BANKING SECTOR • Banking sector plays an important role in the economy of a country. It supplies the life-blood-money that supports and foster growth in any economy.
Primary function of Banks Banks Lending (asset) Accept deposits (liability)
RISK INVOLVED IN BANKS • Credit risk • Business cycle • Firm specific • events • Operational • risk • Human error • Systems failure • Market risk • Interest rates • Exchange rates • Government • policies
Risk management techniques Risk management techniques • On balance sheet • activities • Portfolio • Management • Asset liability • Management • Gap analysis • Off-balance sheet • activities • Overdraft Facilities • Credit Lines • Guarantees • Swap and Hedging • Transactions, etc.
Off-Balance sheet activities: • OBS denotes those activities that involve contingent commitments or contracts which generate income to a bank, but are normally not captured as asset or liabilities under conventional accounting procedure.
Characteristics: • Off balance sheet activities are vehicles of information and risk sharing services. • They seek to unbundled the risk inherent in underlying assets. • They make it possible to repackage such decomposed risks into synthetic product and deal in it separately.
Off- balance Sheet activities Forward contracts Credit Risk Guarantee Market risk Acceptance, Endorsement, etc.
Advantages: • Avoid cash reserves . • Avoid implicit tax. • Passes on the cost of saving to customers.
Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).
Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).
Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).
Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).
Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).
Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).
Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).
Findings: • The exposure of public sector banks to OBS items, has risen 2.3% to Rs19,09,422 Cr. from Rs18,66,824 Cr. in 2009. • Public sector banks have emphasized on guarantee as a major off-balance sheet activity followed by private sector banks and then foreign banks. • Foreign banks’ exposure to derivatives, letters of credit and guarantees declined 31.2% to Rs. 70,20,667 Cr. at the end of March 2009 from Rs.1,02,10,744 Cr. last year.
Cont. • Foreign banks are extensively involved in off-balance sheet activities as compared to private and public sector banks. • They are highly involved in forward contracts, acceptances and endorsements. • It is evident that all the three banking sectors have experienced a decline in off-balance sheet activities in 2009 which may be due to market conditions.
Conclusion: • According to RBI, leveraged positions in derivatives as a means of diversifying income and increasing use of derivatives as tools for risk mitigation appear to have contributed to the growth in contingent liability exposures. • The level of contingent liability exposure of banks have seen significant rise in the last few years as companies rushed to hedge their foreign exchange contracts to tide over the volatility in currency markets except last year, which may be due to prevailing market environment.
Cont. • “Foreign and private banks in 2008-09 on account of the liquidity crunch and rising non-performing loans were reluctant to take exposure on corporates,” said a senior general manager in charge of corporate credit in a Mumbai-based public sector bank. “Corporates were forced to come to public sector banks and hence the rise in guarantees given on behalf of corporates and forward contracts.’’
Cont. • The economic slowdown had affected corporate activity in 2008-09,’’ Expansion, investments and borrowing plans of corporates had slowed down hence the number of forward contracts entered by corporate India saw a dip which also led to a drop in exposure.” Banks have stayed away from the derivative business after some companies took legal action against banks’ mis-selling of exotic derivative products on account of which companies had to incur huge losses.”
Off-balance sheet activities: Road ahead • The future of banking undoubtedly rest on risk management dynamics. • Banks success lies in its ability to assume and aggregate risk within tolerable and manageable limits. • Banks should adopt a coordinated approach to risk management.
