Essays on bank income diversification

This thesis investigates the effects of bank income diversification on bank performance and systemic stability in three independent but complementary empirical studies: The first study reviews the Glass–Steagall Act and similar specialized banking systems from a historic and macroeconomic perspective. The goal is to assess whether past specialized banking systems were introduced for financial stability concerns and whether such regimes entailed positive effects on financial stability. The historic analysis of ten countries that formerly had such regimes in place shows that such regulations were not primarily motivated by financial stability. Based on a panel of thirty high-income jurisdictions between 1970 and 2011 the study further provides an assessment of the effects of such regimes on financial stability. The results do not support the popular belief that specialized banking systems are associated with decreased crisis probability. The analysis instead yields limited evidence of a positive relation. However, the results also indicate that specialized banking systems experience less severe banking crises than universal banking regimes. In contrast to the macro literature, a large body of empirical micro literature on the effects of bank income diversifcation exists. However, this literature provides mixed results. The second study therefore presents a meta-regression analysis on this literature, including thirty-four studies with a total of 932 regressions. The results indicate some evidence for underlying genuine effects: Diversification is generally associated with reduced risk; this includes diversification from interest income towards fee income. Diversification towards trading tends to increase profitability but decreases risk-adjusted profitability. However, the clearest result is that the findings of existing studies crucially depend on research design. The discord in the literature can partially be explained by studies not accounting for endogeneity, thus underestimating the riskiness of trading business. Furthermore, studies focusing on countries that used to separate commercial banking from investment banking tend to find a less positive relation between fee-generating activities and profitability and a more positive relation between trading and profitability. Also, samples with larger banks tend to yield more positive effects from fee-generating and trading activities on profits. The last study analyses the effects of income diversification on large banks. The analysis is based on a panel of ninety large listed international banks from 2005 to 2015. For additional details on banks’ income structure, the data set combines information on fee and trading income, assets under management, and investment banking deal volumes. The results indicate that more diversified large banks are generally less risky and more profitable. The detailed analysis of individual bank activities indicates that fee income outside investment banking and asset management (i.e. retail fees) reduces the risk and increases the profitability of banks. The results further provide some evidence that diversification towards trading and syndicated loans underwriting decreases risk and increases profitability. In contrast, equity underwriting increases risk and decreases profitability and risk-adjusted profitability of banks. In combination, these three studies do not support the hypothesis of specialized banking improving financial stability. Instead, the three studies give a slight indication of universal banking improving the stability of individual banks or the financial system. Overall, the results do not support limiting the business model of universal banks by legally separating commercial banking and investment banking