OFF BALANCE SHEET

ACTIVITIES
CHAPTER 17
OFF BALANCE SHEET
ACTIVITIES

Generates fee income without requiring an

investment of funds

Creates contingent obligation for banks

OFF BALANCE SHEET
ACTIVITIES
LOAN COMMITMENTS

STANDBY LETTERS OF CREDIT

FORWARD CONTRACTS ON CURRENCIES

INTEREST RATE SWAP CONTRACTS

CREDIT DEFAULT SWAP CONTRACTS

LOAN COMMITMENTS

The bank is obligated to provide a specified loan

amount to a particular firm upon a firm’s request

The interest rate and purpose are specified

The bank charges a fee for offering the

commitment
NOTE ISSUANCE
FACILITIES

The bank agrees to purchase a commercial paper

of a firm if the firm cannot place its paper in the
market at an acceptable interest rate

The bank incurs the risk of liquidity if numerous

firms request their loans at the same time
STANDBY LETTERS OF
CREDIT

backs a customer’s obligation to a third party

the bank will meet the customer’s obligation if he

fails to do so

The third party may require that a customer obtain

an SLC to complete a business transaction
FORWARD CONTRACTS
ON CURRENCIES
an agreement between customer and a bank to
exchange one currency for another on a particular
future date at a specified exchange rate

customers that desire to hedge their exchange

rate risk

The bank is exposed to the risk of default when it

acts as an intermediary
INTEREST RATE SWAP
CONTRACTS
The bank acts as intermediary whereby two parties agree
to periodically exchange interest payments on a specified
notional amount principal

The bank acts as a guarantor to both parties, it is

exposed to the risk of default of one of the parties and in
the event of such, the bank fulfills the obligation to the
other party

The bank facilitates credit swaps by finding parties with

opposite future currency needs and executing swap
agreement
CREDIT DEFAULT SWAP
CONTRACTS
In a CDS, the buyer of the swap makes payments
to the swap's seller until the maturity date of a
contract. In return, the seller agrees that – in the
event that the debt issuer (borrower) defaults or
experiences another credit event – the seller will
pay the buyer the security's value as well as
all interest payments that would have been paid
between that time and the security's maturity date.
CREDIT DEFAULT SWAP
CONTRACTS
are previously negotiated contracts that protect investors against the
risk of default on particular debt securities

Bank buys: to protect their own investments in debt securities

Bank sells: receive periodic coupon payments for the term of the
swap agreement, benefit when there is no default because they are
not required to make any payments

When there are defaults on the debt security, the sellers must
make payments to cover the damages

in essence, it provide insurance against default

Typical term of a credit default swap is 5 years

INTERNATIONAL BANKING
GLOBAL COMPETITION IN
FOREIGN COUNTRIES
Listing Branches

most common way for US commercial banks to

expand internationally

compete directly with other banks located in a

particular area

Subsidaries
IMPACT OF THE EURO ON
GLOBAL COMPETITION
The use of a single currency in a number of European
countries simplifies transactions

Reduces exchange rate risk

Encourage firms to engage in bond and stock

offerings to support their European business

Allows banks to easily achieve economies of scale

and internal reporting system to be efficient

Forces banks to be competitive