The "market discipline" of off-balance sheet banking activities (OBSA) has been reexamined by employing contingent claims valuation techniques to derive implied asset variances from bank equity and deposit insurance, and from risk-premia for bank subordinated debt. Specifically implied asset variances have been calculated from contingent valuation models and have been regressed over on-balance accounting risk variables and off-balance sheet activities. These implied asset variances are better than equity variance or risk-premia in proxying total risk because they consider both the non-linear nature of contingent claims model and the impact of closure rules. Empirical results document the existence of "market discipline" of some OBSA. Market participants price these OBSA as risk-reducing. Therefore, regulatory additional capital requirements of such OBS may be inappropriate.
Hassan, M. Kabir; Karels, Gordon V.; and Peterson, Manferd O., "Deposit insurance, market discipline and off-balance sheet banking risk of large U.S. commercial banks" (1991). Department of Economics and Finance Working Papers, 1991-2006. Paper 52.