Question

All of the following items/transactions are off-balance sheet items for a bank, except:

I A documentary letter of credit provided by the bank to a Japanese importer on behalf of an Australian livestock exporter and secured against a shipment of sheep in transit, with the bank making payment to the exporter only once the goods are confirmed as delivered.

II A standby letter of credit provided by the bank on behalf of a U.S.-based firm purchasing a gas turbine from a Swiss manufacturer, with the bank making payment only in the event that the U.S. firm fails to.

III A credit derivative provided by the bank to a hedge fund, whereby the bank will make a compensation payment to the holder if the Greek government defaults on their debt.

IV A performance bond provided by the bank to UNSW on behalf of a construction firm bidding to upgrade student learning spaces around the Quadrangle.

V   A credit card limit provided by the bank that has been fully drawn down and used by the card holder.

Select one:

I and III

II

IV

All of the options listed are off balance sheet items.

III

I

V

Answer 1

Off balance sheet transactions enable business to manage cash flow and credit risks. Off balance sheet transactions are assets or liabilities that are not booked on balance sheet.

Option (d) is correct. All of the options listed are off balance sheet items.

A documentary letter of credit is an off balance sheet item.

A standby letter of credit is seen as a guarantee provided and hence are off balance sheet item.

Derivatives are off balance sheet items as they are contingent liabilities and may be exposed to credit risk, liquidity risk or counter party risk.

Performance bond do not impact the balance sheet, hence they are off balance sheet items.

A common example of an off balance sheet item is a credit card account - the difference between the current balance on account and credit limit.