During the 2008 global financial crisis, financial institutions in the United States experienced big losses, and some firms failed. These failures occurred despite the external and internal regulatory mechanisms imposed upon the financial sector aimed at ensuring confidence and stability in the financial system. This study analyzes the impact of macroeconomic and financial stress on the profitability of financial firms. We utilize data from 1980 to 2010 to model firm profitability and stock returns using a panel regression, fixed-effect methodology. Our results show that the profitability of all firms is negatively affected by increases in macroeconomic and financial stress, measured by the National Financial Conditions Index (NFCI) and the Adjusted National Financial Conditions Index (ANFCI), respectively; however financial sector firms have exhibited an increased marginal sensitivity to both stress indexes that began in the 1990s and continued through the financial crisis of 2008. In a further analysis of the financial sector and banks, we show that depository institutions are relatively robust to macroeconomic and financial stress, and financial sector instability is driven by non-depository finance, investment, and real estate firms. Additionally, the largest 33 percent of financial firms and banks exhibit increased sensitivity to macroeconomic stress in the most recent sample. Our results coincide with the risks associated with recent trends in the financial services industry, such as deregulation, global market integration, financial product innovation, and the increasing predominance of non-depository intermediation.
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