After the financial crisis shook the foundation of the industry, the importance of risk analysis and mitigation within financial institutions became vital to the future health of commercial banks and the financial industry as a whole. Through the analysis of financial statements creditors, depositors, regulators and stockholders are able to assess a commercial banks risk and overall performance. While a Bank’s balance sheet provides a record of the institutions assets, liabilities and equity, it does not reflect all the entirety of the banks activities. As a result, when reviewing the financial performance of a commercial bank, one also needs to be familiar with the institutions off-balance-sheet (OBS) activities, in order to gain a full picture of the bank’s assets and liabilities (Saunders & Cornett, 2015). Therefore, OBS activities are an essential component to realizing the overall risk associated with a commercial bank.
Within todays financial markets, the use OBS activities within commercial banks are becoming increasingly more common as banking institutions fight to turn a greater profit. To be more specific, OBS items include fee related assets or liabilities that are not included on the organizations standard balance sheet. In addition, OBS financing occurs when financing is “obtained by means other than debt and equity instruments, for example partnerships, joint ventures, and leases” (Off-balance-sheet financing, 2007). The organization generally does not have a legal claim or responsibilities over the assets and liabilities reported on the OBS. Consequently, these items are more difficult to track and making it easier for financial institutions ...
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...ed with OBS items, however, the contingent credit risk and default risk of derivatives is high (Saunders & Cornett 2015). Therefore, each OBS item contributes greatly to the inherent risk of commercial banks, however, by properly balancing the duration of the liabilities and assets of OBS items financial institutions can mitigate this risk.
Overall, off-balance sheet items are fee related assets or liabilities not included on the balance sheet. These activities include loan commitments, guarantees, loans sold, and derivative contracts. The OBS activities are realized on the balance sheet once a contingent event occurs and as such they can drastically alter a commercial banks future cash flow. Through assessing the OBS activities, one can mitigate the high level risk associate with such item and help balance the future prosperity of the organization.
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