Off-balance-sheet finance

This technique allows a borrower to legally raise finance (so improving its cash position) without showing any associated liability on the balance sheet. Because of that, it can flatter key ratios such as gearing (debt finance as a proportion of total outstanding finance). Usually a separate ‘special purpose vehicle’ (SPV – another company) is set up first to facilitate this type of deal.

So for example a bank may sell a package of outstanding mortgage receivables to an SPV in return for cash. The SPV raises the money needed to buy the mortgages from the bank by issuing its own ‘mortgage backed securities’ to investors. If the bank can persuade regulators that any subsequent claims by the SPV’s creditors should be met from the pool of assets (mortgage-backed securities) held by the SPV, the associated liability remains in the books of the SPV and not the bank. As such the obligation to repay the debt issued by the SPV remains off the bank’s balance sheet.

• See Tim Bennett’s video tutorial: What is a balance sheet?

MoneyWeek magazine

Latest issue:

Magazine cover
A new dawn for energy

Our experts pick the stocks to buy

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

FREE REPORT:
What you should really do with your money (2014 Edition)


How to buy and sell penny shares

A beginner's guide to investing in gold

How to invest in British fracking