Leverage is one of the key underlying features of banks' balance sheets. Traditionally, leverage arises directly through the use of deposited funds or other balance-sheet items, such as bonds and credit lines, as a supplementary tool of banks' equity capital in financing fresh loans and investments. However, leverage can also be traced off the balance sheet of banking organisations. Indeed, in the years before the outbreak of the late 2000s crisis, banking firms took advantage of financial engineering which allowed them to transfer a large part of their leverage off their balance sheets. This Chapter empirically examines how modern banking and the related off-balance-sheet leverage activities have affected the individual soundness of U.S. banks, as well as the systemic health of the U.S. banking industry, both before and after the onset of the crisis. The obtained results demonstrate that off-balance-sheet leverage largely contributes to both total bank risk and to systemic risk. More concretely, we lend support to the view that, before the onset of the crisis, banks accumulated leverage both on and especially off their balance sheets. Nevertheless, a much more tangible threat to systemic stability was formed after the beginning of the crisis when banks started to dispose of the large number of bad assets they held either in their portfolio or out of it. The deleveraging process, which mainly took place off the balance sheet of banks, is found to be beneficial for individual banks' health, but harmful for the stability of the system as a whole. Our findings suggest that it is crucial for bank managers to carefully look at different measures of performance from a microperspective view (profitability measures, risk measures, etc.), while also paying special attention to the broader, systemic aspects of the operation of their banks. Moreover, managers are expected to act more prudently and keep an eye on the level of their off-balance-sheet leverage exposure, and also think of setting some specific internal limits to this sort of activities if needed. These kinds of limits should be complementary to the various microprudential and macroprudential restrictions imposed by bank regulators under Basel III. Nonetheless, for bank managers to act in a prudent manner, a risk-based remuneration framework needs to be established under Basel III to prevent them from excessive risk-taking
