Off-Balance-Sheet Activities and the Shadow Banking System: An Application of the Hausman Test with Higher Moments Instruments

Abstract

The noninterest income banks generate from their off-balance-sheet activities contributes greatly to the volatility of their operating revenues. Using Canadian data, we apply a modified Hausman procedure based on higher moments instruments and revisit this phenomenon to establish that the share of noninterest income (snonin) is actually endogenous to banks returns. In 1997, after the adoption of the Value at Risk (VaR) as a measure of banks risk, the snonin sign turns positive in the returns equations, indicating the emergence of diversification gains from banks non-traditional activities. ARCH-M estimations corroborate the idea that banks have gradually adapted to their new business lines, with an adjustment process begun even before 1997. However, the banks risk premium associated to OBS activities has continuously increased since that date.Bank Risk Measures; Diversification; Noninterest income; Hausman test; Endogeneity; ARCH-M.