Which of the following regarding loan commitments is false? a. Loan commitments

Question

Which of the following regarding loan commitments is false?

a. Loan commitments are an off balance sheet activity, however it gets recorded on balance sheet when a business draws down on it.

b. A large amount of loan commitments causes high liquidity risk for banks because during economic downturns businesses all require more cash.

c. When a business draws down on a loan commitment, this is reflected on the liabilities side of the balance sheet of banks. On the asset side, cash decreases.

d. During the recent financial crisis, banks that had a lot of loan commitments had high liquidity risk because they didn

Explanation / Answer

Which of the following regarding loan commitments is false?

Answer ; (c) When a business draws down on a loan commitment, this is reflected on the liabilities side of the balance sheet of banks. On the asset side, cash decreases.

When a business draws down on a loan commitment, this is reflected on the asset side and not liability side of the balance sheet of banks. On the asset side, cash decreases & advances increases.

Loan commitment is a formal offer by a lender making explicit the terms under which it agrees to lend money to a borrower over a certain period of time. It is a loan amount due to be contractually funded in the future. Loan commitments are both open-end and closed-end loans. Open-end loan commitments act like revolving credit lines which allows withdrawal upto loan limit all time. Closed-end loans are reduced as any repayments are made. Banks must account for the value of outstanding loan commitments so that funds are available when the borrower request them. They show a full future obligation & It is also known as "unfunded loan commitments," because the total capital funding is not provided by the lender up front. The aggregate loan commitments of banks registered in the United States must be disclosed on quarterly financial reports (known as call reports) to regulators at the FDIC.

Loan commitments are more analysed in economic downturn, as more borrowers delay making repayments. This decreases the return on the capital deployed of bank.

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