Determinants of Off-Balance Sheet (OBS) Activities: A Case of Selected Retail Banks in Malaysia

The present paper examines factors influencing the Off-Balance Sheet activities of selected commercial banks in Malaysia for the period 2004- 2014. OBS activities are an integral part of financial institutions in response to the needs of businesses for different types of guarantee that have conflicting implications on the stability of financial institutions. Data collected on selected banks from the Bankscope database was analyzed using the Generalized Method of Moments (GMM) regression. Specifically, the study built its analysis on three main recognized determining factors namely: (1) liquidity motives, (2) credit risk transfer motive, (3) profitability motives, and (4) capital arbitrage motive. The findings thus suggest that the selected banks mainly used OBS instruments for capital arbitrage purpose, enhancing operational efficiency and managing loan portfolio risks. The findings further suggested that its usage for capital arbitrage purposes may undermine the regulatory measures of accurately estimating and monitoring the risk of banks. The findings thus offer significant practical and policy implications that can help to enhance financial stability. Keywords: off-balance sheet, liquidity, credit risk transfer, profitability, capital arbitrage

Investment Performance of Credit Risk Transfer Securities (CRTs): The Early Evidence

Credit risk transfer (CRT) securities were introduced by Fannie Mae and Freddie Mac in 2013. As of the end of 2017, in combination, the two government sponsored housing enterprises had issued a total of $53 billion in CRTs linked to residential mortgage loans with a total face value of $1.79 trillion. The goal is to shift mortgage risk from tax payers to the private sector. In return, investors expect to be compensated. The authors document the returns earned by investors in the various CRT tranches since their inception. The most senior tranches have provided an average representative return of 0.26% per month. The most junior tranches have provided an average representative return of 1.71% per month. These compare with average monthly returns of 0.03%, 0.15%, and 0.87% to T-bills, 15-year agency mortgage-backed securities, and 10-year high-yield corporate bonds, respectively, over the same time periods.

Editor’s Letter

We begin this issue of The Journal of Fixed Income with two interesting policy articles. First, Chao Gao and John J. McConnell examine the results of shifting mortgage default risk from taxpayers to private investors. The extraordinary returns to investors since inception of the program has provided significant compensation for all tranches of these credit risk transfer securities. The second policy issue is also motivated by the financial crisis of 2008 and its associated financial institution counterparty risk. Issouf Soumaré employs a multifactor econometric model to identify and analyze factors explaining credit value adjustment spreads. Furthermore, the impact of these variables increased with contract maturity.

A NOTE ON CREDIT RISK TRANSFER AND THE MACROECONOMY

The recent financial crisis highlighted the limits of the originate to distribute model of banking, but its nexus with the macroeconomy remains unexplored. I build a business cycle model with banks engaging in credit risk transfer (CRT) under informational externalities. Markets for CRT provide liquidity insurance to banks, but the emergence of a pooling equilibrium can also impair the banks' monitoring incentives. In normal times and in face of standard macro shocks the insurance benefits of CRT prevail and the business cycle is stabilized. In face of financial/liquidity shocks the extent of informational asymmetries is larger and the business cycle is amplified. The macro model with CRT can also reproduce well a number of macro and banking statistics over the period of rapid growth of this banks' business model.