Credit Risk Management Practice Exam

Which method allows banks to mitigate credit risk by temporarily transferring assets out of their balance sheets?

1. Reassignment

2. Marking to market

3. Off-balance-sheet techniques

4. Loan syndication

The correct answer is: Off-balance-sheet techniques

The method that enables banks to mitigate credit risk by temporarily transferring assets out of their balance sheets is off-balance-sheet techniques. This approach involves arrangements that allow banks to keep certain assets or liabilities off their balance sheet. By doing so, banks can reduce their recorded leverage and improve their risk profile, while also freeing up capital for other investments or lending activities. This can involve various mechanisms such as securitization, derivatives, or special purpose vehicles, which help in managing potential risks while maintaining regulatory compliance. Off-balance-sheet techniques are particularly valuable because they allow banks to manage and transfer risk without the immediate impact on their financial statements, thus enhancing their liquidity and overall financial flexibility. This method is crucial when it comes to handling credit risk effectively, as it provides banks with the ability to isolate riskier assets from the rest of their portfolio.