Abstract
Banks have been revising their business models since the financial crisis, diversifying income sources to pursue profitability and stability in a rapidly evolving environment. The effectiveness of this strategy is still debated. We investigate if revenue diversification of 1250 EU and US banks improved performance or its stability between 2008 and 2016. We adopt a broad econometric approach and define diversification as the share of non-interest revenue and the HH index of the net operating income. We find that diversification is not clearly associated with performance or its volatility, that benefits change remarkably over time and, where present, show significant variability. Our results support recent evidence on the limitations of diversification in banking, raising potential concerns on converging supervisory practices and general calls for revenue diversity. The variability of business models and the impacts of different economic and institutional environments matter.
Highlights
The evolution of business models is inherent to allrms
ROAE is more volatile than ROAA and is more in°uenced by bank leverage: we use both variables to cross-check from di®erent points of view the e®ects of revenue diversication on bank protability
Equation (3.3) reports the baseline dynamic panel model used to estimate the e®ects of revenue diversication on banks' risk-return measures. We focus on these variables because they are more appropriate for evaluating bank performance, since they directly account for both the protability and the riskiness
Summary
This process showed an increased speed over the last decade. Leading changes includenancial innovation and technological advances but extend to shifts in clients' behavior and lessons learnt from thenancial crisis and embedded in recent supervisory and regulatory responses. Diversication appears as a natural choice in order to restore or strengthen protability in an uncertain environment. If excessive concentration could threat stability, banking diversication seems unable to be free from drawbacks: the recent academic debate underlines its limitations and the lack of unambiguous results. Supervisors call for more income diversication, especially in Europe where the focus on traditional commercial banking is high. Fee-based revenues could be able to counterbalance the degrading quality of loan portfolios and smooth protability patterns. During recessions, an increase in volatility and covariance of income sources can o®set diversication benets and lead to a return to concentration
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