Do traditional off-balance sheet exposures increase bank risk?

Banks’ off-balance sheet activities are among the many factors blamed for the risk-taking that led to the 2007–2008 financial crisis. We test whether and how off-balance sheet exposures influenced risk-taking at publicly traded commercial banks in the G-7 countries between 1998 and 2018. Contrary to expectations, we find strong evidence that larger off-balance sheet exposures are associated with lower aggregate and idiosyncratic risk but higher tail risk. Further, we observe a non-linear relationship between off-balance sheet activities and risk. Our results suggest that placing absolute limits on OBS activities might increase bank risk-taking.