Banks Non-Interest Income and Global Financial Stability

Abstract

Depositary institutions over the last 15 years have increased the share of non-traditional revenue in total income. While the change in business models is a global phenomenon, it is more pronounced in countries such as the U.S., France and the U.K. In this study, we examine whether market structure can help explain the cross-country variation in the diversification activities that bank choose to pursue. The UK Independent Commission of Banking raised issues related to “ring fencing retail banking from investment banking. The EU’s Liikanen Review and the Dodd-Frank Act in the US proposed policies which may limit trading and proprietary activities of large banks. It is important to understand the motivation behind these choices because non-traditional banking activities have shouldered a large part of the blame for the 2007-2009 financial crisis, and now face the brunt of regulatory efforts. Using a sample of large banks across 38 countries this paper examines how the concentration of the banking system impacts the choice of business activities and consequently the stability of banks. We show that banks in less concentrated banking systems ( such as in the US and Japan) have higher levels of non-traditional business activities with higher shareholder returns, but at a cost of increased systemic risk. In contrast, the non-traditional business activities in highly concentrated banking systems help reduce the volatility of profits and also increase banks stability. Unlike previous research we show that there is not always a one-to-one relationship between non-traditional business activities and global banks stability.

Keywords: Global financial stability, Tournament incentives, Banking system concentration, Income diversification

JEL Classification: G01, G21, G28