Off-balance Sheet Risk Research Articles

AN INSIGHT INTO BANKING SECTOR MERGERS AND ACQUISITION-BRICS NATIONS

The banking and financial services (BFSI) sector is one of the most crucial areas in any economy. It is fastest growing and the listed players in this space has given high returns to the investors over the last decade. Commercial banks in the Indian context have witnessed radical changes in terms of enormous progression in off-balance sheet risk management of financial assets, regulatory amendments, NPA recognition norms, significant consolidation of the financial sector and introduction of e-commerce norms and online banking. In this context, Indian economy is similar to the other economies of BRICS countries. These countries are emerging economies with higher GDPs and undertaking various reforms to boost the consumption, transparency and business needs. So, it is pertinent to evaluate the M&A activities that have taken in India and other BRICS countries and comparing the same. This paper analyses the M&A that have taken place in India and other BRICS countries based on certain fundamental parameters which are based on regulatory requirements, profitability and overall returns on investments. The results of these tests indicate that there is insignificant change in most of parameters during post-merger phase. Further, other parameters showed a negative effect of merger on acquirer during post-merger period. Keywords: Mergers and Acquisitions, BRICS, Financial Performance, Banking Sector JEL Classifications : G34, G21 DOI: https://doi.org/10.32479/ijefi.10091

Competition and commercial banks risk-taking: evidence from Sub-Saharan Africa region

ABSTRACTThis study investigates the relationship between competition and the risk-taking attitude of banks. We test how this relationship manifests in the Sub-Saharan African(SSA) region’s commercial banks in light of the competition-fragility view, using the generalized methods of moments. We studied 440 commercial banks in 37 SSA countries over the period 2006–2015. The results provide evidence that supports a positive relationship between competition and banks’ overall risk as well as their credit risk but suggests that off-balance sheet risk reduces with competition. We, therefore, conclude that the propensity to undertake higher risk in a competitive banking environment largely accounts for fragility as argued in the competition-fragility view.

Development of methodological tools for assessing enterprise credit worthiness taking into account off-balance sheet risks

The article is devoted to the improvement of methodical tools for assessing the credit worthiness of enterprises’ legal entities taking into account the impact of off-balance-sheet risks on the definite integral class of a debtor-borrower. The authors substantiate that the non-accounting of off-balance sheet commitments in assessing the borrower’s credit worthiness leads to false managerial decisions on granting a loan and increasing the level of credit risk of the bank.The purpose of the article is to study the questions of methodical tools for assessing the credit worthiness of economic entities and develop directions for improving its analytical support taking into account the impact of off-balance-sheet risks. The object of the research is the analytical support for assessing the credit worthiness of a borrower-legal entity taking into account off-balance-sheet risks. The authors put forward and proved the hypothesis that, acting as the guarantor or principal of another enterprise, the assessment of the borrower's credit worthiness undergoes significant changes. The coefficient analysis of the methodological provision for assessing the borrower's credit rating by the current method number 351 is carried out, as a result of which the influence on the integral index and the debtor class is proved. When determining the reliability class of the borrower, the most affected are solvency ratios (especially for short-term loans) and financial sustainability (for long-term loans) to the borrower. The current methodology for defining these indicators does not take into account the effect of off-balance sheet risks, which is due to the use of financial reporting data, which does not include data on off-balance sheet instruments. The methodological support of credit-worthiness analysis is proposed, taking into account the impact of off-balance sheet risks on it. The prospects for further research should be formulated in the direction of improving the methodological support of the analysis of credit, taking into account the impact of off-balance-sheet risks on it.

Development of orgware of borrower - legal entity’s solvency analysis

The article is devoted to the development of orgware of borrower - legal entity’s solvency analysis. The authors investigate the orgware of solvency estimation mechanism in two aspects: 1) as the aggregate of the organizational stages of solvency estimation; 2) as an organizational structure and co-operation between different structural subdivisions of bank. The paper itemizes and specifies the stages of orgware of borrower - legal entity’s solvency analysis according to such signs as the purpose of the stage; responsible for the stage; the issues studied on the stage; documenting, duration and features of the organizational stage). The documentary providing of the process organization of solvency analysis is improved, namely, the appendix to executive Summary «Estimation of off-balance sheet obligations (off-balance sheet risks) of borrower on the project credited» is offered. The authors’ attention is paid to the existence (in international practice) of two methods of organization process of enterprises-borrowers’ rating: 1) oriented to the external rating and 2) oriented to the internal rating, their advantages and disadvantages are identified. The article offers the algorithm of informative co-operation of basic subjects of borrower’s solvency analysis after the selected organizational stages at forming of the internal credit rating, which will be instrumental in the improvement of process of enterprises’ crediting, standardization of procedure, and decline of crediting risks.

Incorporating Tunneling Risk into Equity Valuation: an Application to the Oil and Gas Industry

Consider a firm that has high profitability and sales growth relative to peers but a relatively low Tobin’s Q. An ad hoc analysis of that particular firm’s situation might suggest that the apparent valuation discount is caused by off-balance sheet risks. A more systematic framework would be useful to support and confirm the conjecture. This paper offers such framework by first classifying transactions that managers and controlling shareholders can use to tunnel (expropriate wealth) from firms into three types: cash flow, asset, and equity tunneling and then incorporating each type of tunneling into a firm free cash flow valuation model. Based on the model, each type of tunneling affects observed valuation and profitability ratios differently, providing analytical markers useful for determining priced tunneling risks. We apply the integrated tunneling and valuation framework to an analysis of the global oil and gas industry. Cross-sectional and time series differences in the patterns of valuation metrics indicate that the valuations of Russian oil and gas companies are depressed relative to their global peers due to significant asset and equity tunneling risks, but also that investors’ assessment of these tunneling risks changes significantly over time. The results demonstrate that analyzing tunneling risks can enhance existing equity valuation tools.

Derivatives disclosure in corporate annual reports: bank analysts' perceptions of usefulness

Responding to mixed evidence on the decision-usefulness of annual report disclosures for derivative financial instruments to capital market participants, and concerns identified by practice, this paper examines usefulness in a direct study of user perceptions. Interviews with analysts from Australia's four major banks reveal essential usefulness, limited by the disclosures' failure to reflect companies' actual use of derivatives throughout the period, and inability of users to understand companies' off-balance sheet risk and risk management practices from information considered generic and boilerplate. The research complements and extends existing archival and survey research and provides new evidence suggesting low-cost ways for increasing usefulness. It supports the International Accounting Standards Board's disclosure recommendations in its recent Discussion Paper: A Review of the Conceptual Framework for Financial Reporting, but, at the same time, highlights that for these proposed measures to be successful in relation to IFRS 7, they may need to address other issues. The research increases knowledge of the informational requirements of lenders, an important class of financial information user, and supports calls from practice for companies to improve their disclosure of material economic risks.

A Critique of SRISK as an Alternative to Regulatory Leverage Ratio

In the wake of the 2008 financial crisis, Robert Engle and colleagues at New York University developed the NYU Stern Systematic Risk Model (SRISK), a market-based substitute for regulatory measures of systemic risk of financial institutions. This study identifies four shortcomings of SRISK. First, market value is not an adequate substitute for book value in measuring systemic risk. Second, SRISK fails to account for credit derivatives and other off-balance sheet risk. Third, the market data captured by SRISK itself relies on regulatory disclosures. Fourth, SRISK cannot be applied to private firms.

Empirical Analysis of Debt Deflation on a Macro- and Micro-Economic Levels

The paper explores the empirical macro- and microeconomic aspects of debt deflation. After performing VAR and Granger causality analysis on the quarterly 1980-2011 filtered macroeconomic data for the USA, we find evidence for the endogenous money supply theory. Highlighting the empirical observation of the recent credit cycles we put emphasis on the crucial role of banks in determining the broad money supply. Afterwards we use the microeconomic annual 2008-2010 data on 459 banks and a set of logit models to show the role of capital and leverage adequacy benchmarks in predicting bank failure. We find indirect evidence for the benchmarks to function as self-fulfilling prophecies. After introducing control variables we find leverage ratio to be one of the most significant and robust predictors of bank failure. In addition, off-balance sheet risks tend to outweigh all other types of risks.

Off-Balance Sheet Risk : Evidence from Malaysian Islamic and Conventional Banks

Off-Balance Sheet Risk : Evidence from Malaysian Islamic and Conventional Banks

The Determinants of Yield Spreads and the Market Discipline of Banks

Determinants of yield spreads vary with market conditions and available information, which has implications for debt pricing models. After the bailout of Long Term Capital Management (LTCM) in September 1998, important firm-specific default risk measures, such as leverage, are not significant factors in determining yield spread levels of bank-issued subordinated notes and debentures (SND) because these measures do not reflect the true risk of the firm. Bond markets impound a higher cost for higher risk-taking, particularly for off-balance sheet risks, based on return-on-assets, after the LTCM bailout, Yield spreads have become less sensitive to firm-specific risks, even prior to the LTCM bailout, after the issuance of trust-preferred securities (TPS) by banks because TPS are junior claims to SND and provide an additional buffer to SND from default risk. Yield spreads on SND prior to TPS issuance by banks and the LTCM bailout are sensitive to conventional firm-specific risk measures. Yield spreads on TPS at the time of offer provide market signals about on-balance sheet risks.

Earnings Quality, Off-Balance Sheet Risk, and the Financial-Components Approach to Accounting for Transfers of Financial Assets

Two standard setting approaches have emerged globally to guide the choice of accounting for securitizations: the control and components approach (FAS125/FAS140) and the risks and rewards transfer approach (IAS39). A lack of consensus about derecognition accounting is a major impediment to achieving convergence in global standards that must be resolved. Thus, both FAS140 and IAS39 will be re-examined and evidence pertinent to the debate is timely and important. In this study, we present evidence consistent with the view of credit rating analysts, who view securitizations as in substance secured borrowings. Specifically, for a sample of originators applying sale accounting guidance in FAS125 during the period 1997-2000, we show that off-balance sheet debt related to securitizations has the same risk relevance for explaining market measures of risk (i.e., CAPM beta) as on-balance sheet debt. We also find that securitization gains receive a lower pricing multiple, relative to net income excluding such gains, and in particular, the pricing multiple declines as the amount of off-balance sheet debt increases, implying increasing skepticism of investors about the valuation relevance of front-end-loaded gains on sale as the extent of off-balance sheet financing activity related to securitizations increases. It would appear that current gain recognition is premature for the high levels of financial leverage implicit in many securitization deals.

Corporate Governance and Depository Institutions Failure: The Case of an Emerging Market Economy

In this paper we study the relationship that exists between ownership and governance structure of depository institutions (DI) on one side, and the dominant cause of failure on the other. Extant theory implies that in stock owned DI where management is either well controled (through markets or board control) or interests are aligned with those of shareholders, the dominant cause of failure will be moral hazard between shareholders and debtholders, manifested in balance sheet or off-balance sheet risk taking. On the other hand, in DI of diffuse ownership with poor management control or where management's interests are not alligned with those of owners, the dominant cause of failure will be agency costs, manifested in expense preference behavior that leads to failure. We exploit the opportunity that offers the Colombian crisis of banks and financial cooperatives (FC) and the relatively good quality of data available for this country to perform the study. Our objective is to establish empirically the relative importance of these two conflicts as determinants of insolvency in DI. Results suggest that, in the case of Colombia, moral hazard is a key factor in explaining bank failure while agency costs explain insolvencies among FC. In state-owned banks both moral hazard and agency costs are signifficant in explaining failure.

What Can Bank Supervisors Learn from Equity Markets?

Much recent academic attention has focused on the relative ability of markets and bank supervisors to assess the risk of depository institutions. We add to that literature by comparing the factors influencing bank holding company risk, as gauged by equity markets, with the factors influencing the confidential BOPEC scores, as awarded by bank supervisors. Specifically, we regress stock market measures of holding company risk and BOPEC scores on a host of on- and off-balance sheet risk measures taken from the Federal Reserve's Consolidated Financial Statements for Bank Holding Companies (FR Y-9C reports). Our sample includes data from 1988 through 1993. We estimate regressions year by year on a sample of 98 holding companies, with yearly observations ranging from 69 to 79. The results suggest that both equity markets and regulators closely scrutinize credit risk. Beyond that, the results suggest that regulators pay close attention to capital strength. Taken together, the evidence supports the view that the stock market emphasizes risk-return trade-offs, whereas regulators care more about probability of failure.

Off-balance sheet risks: What are they and why is their disclosure important?

General Motors (GM) has broken a record. The Big-Three automaker posted a phenomenal $23.5 billion loss for fiscal year 1992 (White, 1993, p. A3). Paradoxically, this world-record loss accompanied reports that GM generated income of $92 million from operations in 1992 (Dubrowski, 1993). The accounting data seem contradictory: How could GM incur a record loss when its operations are improving? The answer: GM recorded a “one-time hit.” Company executives recognized the cumulative effect of previously undisclosed liabilities for postretirement benefits -namely, a $20.8 billion obligation for retiree medical benefits. Prior to issuance of GM’s 1992 financial statements, these liabilities were off-balance sheet. That is, they existed outside the realm of financial reporting. GM is not alone. Many companies maintain off-balance sheet assets and liabilities. This essay explores some of the critical issues surrounding off-balance sheet risks (O&S&), namely, (1) the nature of OBSR, (2) managerial motivation to pursue off-balance sheet activities, (3) the importance of disclosing these activities, and (4) the Financial Accounting Standards Board (FASB) crusade to control OBSR.