Bank income structure and risk: An empirical analysis of European banks

Abstract

International audienceThe purpose of this paper is to investigate the relationship between bank risk and product diversification in the changing structure of the European banking industry. Based on a broad set of European banks for the period 1996-2002, our study first shows that banks expanding into non-interest income activities present higher risk and higher insolvency risk than banks which mainly supply loans. However, considering size effects and splitting non-interest activities into both trading activities and commission and fee activities we show that the positive link with risk is mostly accurate for small banks and essentially driven by commission and fee activities. A higher share of trading activities is never associated with higher risk and for small banks it implies, in some cases, lower asset and default risks

Heterogeneous Effects of Risk-Taking on Bank Efficiency: A Stochastic Frontier Model with Random Coefficients

“…This contrasts with recent empirical literature that illustrates how most of bank inefficiency corresponds to either poor management or riskier strategies reflected in a higher ex-post credit risk (i.e. elevated share of NPLs) (see Lepetit et al, 2008).…”

“…Similarly, traditional measures of market risk exposure such as securities over total assets and capital risk exposure (equity capital over total assets) may help to capture market and regulatory conditions that affects banks performance. These risks have been incorporated in estimations of cost and profit functions in some studies showing its importance on bank performance (Altunbas et al, 2000;Athanasoglou et al, 2008;Brissimis et al, 2008;Lepetit et al, 2008). Overall, banks face different types of risks that influence their performance, and they should be accounted for in bank efficiency measurements.…”

“…Most of them show that because of banks can choose their level of operating costs, monitoring cots and capitalization to manage their level of risk exposure (e.g. adequate proportion of riskier loans), the consequences of a bad management or higher risk-taking, by skimping or moral hazard incentives, would lead to both inefficiency and higher bad loans (see Williams, 2004;Altunbas et al, 2007;Lepetit et al, 2008;Podpiera and Weill, 2008;Tabak et al, 2011).In general, they find a negative relationship between NPLs and cost efficiency and concur that banking supervisors should focus on enhancing bank cost efficiency and bank capital in order to reduce the probability of bank failures and to support financial stability objectives. However, little is known about how differences in risk exposure affect the efficiency of banks with different characteristics.…”

What drives investment bank performance? The role of risk, liquidity and fees prior to and during the crisis

“…Moreover, De-Young and Roland (2001) argue that the substitution of traditional operations with fee-income activities is related to an instability of earnings, while Acharya et al (2006) show that banks with higher inclusion of non-interest income activities in their portfolio perform less efficiently than banks with lower involvement in fee-income operations. In the same manner, Stiroh (2004) and Lepetit et al (2008) find a positive association between fee-based revenue and bank risk. Yet for saving banks an increase in fee-income could have a positive impact on performance (Chiorazzo et al, 2008), as these banks engage in both interest and non-interest income operations and thereby diversify their risk (De-Young and Rice, 2004).…”

“…The Z-Score has been used widely in recent banking studies (Lepetit et al, 2008;Barry et al, 2011;Radic et al, 2012). Banks with lower Z-Score have higher risk to default than banks with higher Z-Score.…”