off-balance sheet activities in indian banks

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

Accept deposits(liability)

Lending(asset)

RISK INVOLVED IN BANKSRISK INVOLVED IN BANKS

Market riskMarket risk•Interest ratesInterest rates•Exchange rates Exchange rates •GovernmentGovernment policiespolicies

Credit riskCredit risk•Business cycleBusiness cycle•Firm specificFirm specific eventsevents

Operationalrisk•Human error•Systems failure

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.

Credit Risk

Market risk

Forward contracts

Guarantee

Acceptance, Endorsement, etc.

Off-balanceSheet

activities

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).

Total Off-balance sheet activities in Public Sector Bank

0

500000

1000000

1500000

2000000

2500000

2002 2003 2004 2005 2006 2007 2008 2009

Years

Amt. i

n Cr. Public Sector Banks

Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).

Total Off-balance sheet activities in Private Sector Banks

0500000

100000015000002000000

25000003000000

Years

Am

t. i

n C

r.

Private Sector Banks

Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).

Total Off-balance sheet activities in Foreign Banks

0

2000000

4000000

6000000

8000000

10000000

12000000

2002 2003 2004 2005 2006 2007 2008 2009

Years

Am

t. i

n C

r.

Foreign Banks

Off-balance sheet activities of Different Banks

0

2000000

4000000

6000000

8000000

10000000

12000000

Years

Am

t. i

n C

r. Public Sector Banks

Private Sector Banks

Foreign Banks

Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).

Forward Exchange Contracts in Banks

0

2000000

4000000

6000000

8000000

10000000

2002 2003 2004 2005 2006 2007 2008 2009

Years

Amt.

in C

r.

Public Sector Banks

Private Sector Banks

Foreign Banks

Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).

Guarantees given in Banks

0.00

50,000.00

100,000.00

150,000.00

200,000.00

250,000.00

300,000.00

2002 2003 2004 2005 2006 2007 2008 2009

Years

Amt.

in C

r. Public Sector Banks

Private Sector Banks

Foreign Banks

Source: Off-Balance Sheet exposures of Scheduled Commercial Banks (2002-09).

Acceptances, Endorsements, etc. in Banks

0.00

200,000.00

400,000.00

600,000.00

800,000.00

1,000,000.00

1,200,000.00

1,400,000.00

1,600,000.00

1,800,000.00

2002 2003 2004 2005 2006 2007 2008 2009

Years

Am

t. in

Cr. Public Sector Banks

Private Sector Banks

Foreign Banks

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.

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