The risk incurred by the financial institutions due to their activities related to the contingent assets and liabilities. For financial institutions to some extent engage in the off-balance sheet activities. An off-balance sheet activity does not appear on the financial intuitions balance sheet rather it is shown as a note bellow the balance sheet. Now off-balance sheet activities can affect the future shape of the financial institution’s balance sheet & thus can be a significant source of risk exposure.
Off-balance sheet Risk — “the risk posed by factors not appearing on an insurer's or reinsurer's balance sheet. Excessive (imprudent) growth and legal precedents affecting defense cost coverage are examples of off-balance-sheet risk.”
Off-balance sheet Risk is a risk related to the excessive growth rate in contingencies and premiums e.g. requirements of the affiliate company.
There are mainly, three types of off-balance risks. These are as follows:
- Funding and Liquidity Risk in Banks: Off-balance sheet liquidity risk sources for banks. These include items which may cause additional funding demands in the future:
- Undrawn lending facilities.
- Contingent liabilities e.g. guarantee.
- Securitization vehicles for special purposes.
- Derivative instruments.
- Bank’s Capital Risks: Risks of negative effects on the capital and profits of the bank from similar off-balance sheet sources.
- An organization’s any risk arising from contingencies, relationship, or events not recorded in the balance sheet of the organization. For instance, repo-to-maturity transactions.
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