Bankss Non-Traditional Activities Under Regulatory Changes: Impact on Risk, Performance and Capital Adequacy

Abstract

Using the big six Canadian chartered banks quarterly financial statements and daily stock market data from 1982 to 2010, we examine the impact of non-interest income on Canadian banks’ risk, performance and capital under the different major regulatory changes made to the Bank Act of Canada. We document a significant increasing trend in non-interest income with a substitution effect between non-interest income and net interest margin following the 1987 amendment to the Bank Act allowing commercial banks to acquire (or merge with) investment dealers and brokerage firms. Our results show that Canadian banks’ expansion into non-traditional activities had resulted into decreased risk and increased performance benefitting from income diversification. Moreover, while adhering to capital adequacy regulation, reshuffling banks’ portfolio towards non-traditional activities did not reduce Canadian banks’ capital ratio, buttressing the effectiveness of capital adequacy regulation in Canada in linking banks capital allocation with their risk taking in spite of the re-regulation towards universal banking.