Banks' off-balance-sheet items on the rise

Off-balance-sheet exposures in banks have shown a sharp rise in the year-ended March 2011. These items grew by 32 per cent year-on-year in this period. In absolute terms, these liabilities are almost double the size of banks' total assets.

Off-balance sheet (OBS) items for banks include forward contracts of clients, bank guarantees and bankers' acceptances (acceptance is a bill of exchange drawn on and 'accepted' by a bank as its commitment to pay a third party in international trade). These exposures earn fee income; however, any slippage in this portfolio would affect the bottom-line.

Historically, there were issues with credit derivative products sold by private banks. In extreme scenarios, it can cause systemic disruption, as these exposures are far larger than the balance-sheet sizes.

Despite the increase in OBS exposures last fiscal, the outstanding amount is still below the highs of 2007-08. In March 2008, banks' OBS exposure accounted for more than three times their balance-sheet sizes.

Foreign banks, the market leaders

Foreign banks, which make up for 6.8 per cent share in the total assets of the banking system, account for a disproportionate 67 per cent share in overall banks' off-balance sheet exposure. Their expertise in providing risk management solutions has helped them corner a major share. The off-balance-sheet exposures of foreign banks are close to 19 times their balance-sheet sizes.

As of March 2011, new private banks and public sector banks have a 16 per cent share each in this OBS exposure. Public sector banks and new private banks have 73.6 per cent and 15 per cent shares respectively in total assets.

Thanks to larger share in on-balance sheet items, public sector banks' OBS exposure, as a proportion of balance-sheet size, was only 41 per cent as of March 2011 with almost half the off-balance sheet exposure coming from giving guarantees and bank acceptances.

‘Other income' and profitability

Rising OBS exposure has been the reason for increase in other income for banks. The RBI's report titled “Trends and Progress of Banking in India'' has done a study on off-balance-sheet exposure and profitability. The study shows that for every 1 per cent rise in OBS exposure, the other income increases by 0.08 per cent.

As of March 2011, the other income, as a proportion of net revenues for foreign banks and new private banks, stood at 38 per cent and 36 per cent respectively. In the case of public sector banks, which have relatively lower exposure to OBS items, the share of other income is 26 per cent.

Because the off-balance-sheet items are not captured in return ratios of banks, the return on assets ratio looks better for new private banks and foreign banks compared to public sector banks.

For instance, a 34 per cent rise year-on-year in contingent liabilities of foreign banks may partly be the reason for its return on asset improving from 1.26 per cent in March 2010 to 1.74 per cent in March 2011.

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