Working Paper: CEPR ID: DP7170
Authors: Asli Demirgüç-Kunt; Harry Huizinga
Abstract: This paper examines the implications of bank activity and short-term funding strategies for bank risk and return using an international sample of 1334 banks in 101 countries leading up to the 2007 financial crisis. Expansion into non-interest income generating activities such as trading increases the rate of return on assets, and it may offer some risk diversification benefits at very low levels. Non-deposit, wholesale funding in contrast lowers the rate of return on assets, while it can offer some risk reduction at commonly observed low levels of non-deposit funding. A sizeable proportion of banks, however, attract most of their short-term funding in the form of non-deposits at a cost of enhanced bank fragility. Overall, banking strategies that rely prominently on generating non-interest income or attracting non-deposit funding are very risky, consistent with the demise of the U.S. investment banking sector.
Keywords: bank fragility; financial crisis; noninterest income share; universal banking; wholesale funding
JEL Codes: G1; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| noninterest income-generating activities (G29) | rate of return on assets (G32) |
| noninterest income-generating activities (G29) | risk diversification benefits (G11) |
| nondeposit wholesale funding (G29) | rate of return on assets (G32) |
| nondeposit wholesale funding (G29) | bank fragility (F65) |
| noninterest income-generating activities (G29) | bank fragility (F65) |
| fee income share (G29) | risk (D81) |