Diversification in Banking: Is Noninterest Income the Answer?

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractThe U.S. banking industry is steadily increasing its reliance on nontraditional business activities that generate fee income, trading revenue, and other types of noninterest income. This paper assesses potential diversification benefits from this shift. At the aggregate level, declining volatility of net operating revenue reflects reduced volatility of net interest income, rather than diversification benefits from noninterest income, which is quite volatile and has become more correlated with net interest income. At the bank level, growth rates of net interest income and noninterest income have also become more correlated in recent years. Finally, greater reliance on noninterest income, particularly trading revenue, is associated with higher risk and lower risk-adjusted profits. These results suggest little obvious diversification benefit from the ongoing shift toward noninterest income. *

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 effects of focus versus diversification on bank performance: Evidence from Chinese banks

“…Similarly, Stiroh (2004) documents that noninterest diversification is negatively linked with performance. Acharya et al (2006) provide results suggesting that there are diseconomies of scope that arise through weakened monitoring incentives and a poorer-quality loan portfolio when a risky bank expands into additional industries and sectors, complementing the agency-theoretic analysis of the boundaries of a bank's activities as proposed in Cerasi and Daltung (2000).…”

Income Diversification in the German Banking Industry

“…Third, in contrast to the lending business, fee-based activities require less regulatory capital, which suggests a higher degree of financial leverage and therefore leads to a higher earnings volatility. Indeed, DeYoung and Roland (2001) and Stiroh (2004a) find empirical evidence that reliance on non-interest activities increases the volatility of large U.S. banks. In general, only a few papers identify empirical evidence that combined lending and non-interest activities cause diversification benefits and therefore lead to risk reduction.…”

“…By contrast, there are some studies (mainly for the US banking market) that have shown a positive and significant influence of diversification through non-interest income on earnings volatility. 5 Stiroh (2004a) analyzes the potential benefit of income diversification for U.S. banks. Since the growth of net interest and net non-interest income in the period 1984-2001 is increasingly correlated, he concludes that the diversification benefits decreased during the period in question.…”

“…Stiroh and Rumble (2006), Stiroh (2004b), Mercieca et al (2007) and Chiorazzo et al (2008) differentiate between a "direct exposure" effect (a greater reliance on non-interest activity) and an "indirect diversification effect" (change of concentration between the two income streams), whereby the latter is measured by the Herfindahl Hirschmann Index (HHI). Indeed, Stiroh and Rumble (2006), Stiroh (2004a) and Mercieca et al (2007) show that for small European banks, small U.S. community banks and U.S. financial holding companies higher concentration is accompanied by a lower degree of income volatility, while shifting into non-interest income creates an inefficient trade-off between risk and return. Furthermore, all three studies conclude that the banks' financial stability, measured through z-score, is negatively affected by reliance on non-interest income.…”