What are off-balance-sheet items, why are they so important to some financial firms?

Evaluate them with relevant examples.

Answer: Off-balance sheet items is a term for assets or liabilities which do not appear on a
company's balance sheet. Although not recorded on the balance sheet, they are still assets and
liabilities of the company but typically they are not owned by or are a direct obligation of the
company. Some off-balance sheet items are:
 Unused Loan Commitments
 Standby Credit Agreements
 Derivative Contracts
Off-balance sheet items are important as a supplement to income from loans and to help a
bank reduce its exposure to interest-rate and other types of risk.
Some examples to evaluate off- balance sheet items:
1. Unused Loan Commitments: In this type of item, a lender receives a fee to lend up
to a certain amount of money over a defined period of time; however, these funds
have not yet been transferred from lender to borrower.
2. Standby credit agreements: In this item a financial firm receives a fee to guarantee
repayment of a loan that a customer has received from another lender.
3. Derivative contracts: These are asset which are not owned by a firm but generate
income or incur losses. This category includes futures contracts, options, and swaps that
can be used to hedge credit risk, interest rate risk, foreign exchange (currency) risk,
commodity risk, and risk surrounding the ownership of equity securities.