3.8 Off-Balance Sheet Activities
What is the difference between a commercial Let of Credit and SBLC?
---Commercial facilitates the sale of goods and is expected to be drawn upon by the beneficiary in the normal course of business. ---SBLC is not generally expected to be used unless the account patty defaults in meeting an obligation to the beneficiary.
Standby LOC can be participated or syndicated
---Participation =originating bank must honor all drafts whether or not the participants are willing or able to disburse their pro rate share. ---Syndications =represent legal apportionments of liability. If one of the banks fails to fulfills its obligations under the SBLC, the remaining banks are not liable for that bank's share.
Off-balance sheet contingent liabilities? (Always be running)
-Asset-backed commercial paper programs -Bankers acceptance -Revolving underwriting facilities -Standby LOC issued by another depository institution
Risks of a Standby Letter of Credit? (2)
-Credit risk-possibility of default of the part of the account party -Funding risk- potential inability of the bank to fund large draw from normal sources
document issued by a bank on behalf of its customer authorizing a third party to draw drafts on the bank up to a stipulated amount under specific terms and conditions.
-Letter of credit -conditional commitment (except when prepaid by the account party) on the bank's part to pay drafts drawn in accordance with the document's terms.
Off balance sheet lending activities
-Letters of Credit -Loan commitments
Transfer of financial assets? 4
-Mortgage banking -Financial assets sold without recourse -Financial assets sold with recourse -Recourse and direct credit substitutes
4 types of letters of credit? (TTCS)
-Travelers - generally sold for cash -Those sold for cash - not reported as a contingent liability, but rather as a demand deposit -Commercial —issued specifically to facilitate trade or commerce. Drafts will be drawn when the underlying transaction is consummated as intended. -Standby - irrevocable commitment on the part of the issuing bank to make payment to a designated beneficiary.
The classification of Category I contingencies is dependent upon two factors:
-likelihood of the liability becoming direct -Credit risk of the potential acquired asset
defined as liabilities that will give rise to a corresponding increase in bank assets if the contingencies convert into actual liabilities.
Category 1
there will be no equivalent increase in assets if a contingency becomes a direct liability.
Category 2
What is less detailed than a formal loan commitment?
Line of credit
Written agreement, signed by the borrower and bank, detailing the terms and conditions under which the bank will fund a loan...
Loan commitment
is a commitment by a group of banks to purchase, at a fixed spread over some interest rate index, the short-term notes that the issuer/borrower is unable to sell in the Euro markets, at or below the predetermined rate.
Revolving underwriting facility
How can off balance sheet activities benefit earnings?
The use of off-balance sheet activities may improve earnings ratios because earnings generated from the activities are included in the income numerator, while the balance of total assets included in the denominator remains unchanged.
