Model of Risk Diversification in the Banking Sector

In: Folia Oeconomica Stetinensia, Band 19, Heft 1, S. 31-42

Abstract

Abstract

Research background: Motivation for this study is the rapid development of conglomerate banking stimulated by the synergy between the traditional and parallel investment activity of banks before the 2007–2008 financial crisis. Existing studies do not answer the question about the positive influence of diversification on bank stability. They state that the combination of lending and non-interest income allows benefits to be derived from risk diversification. However, on the other hand they emphasise that non-interest and interest incomes are strongly correlated, which does not bring positive effects from diversification.

Purpose: Scientific problem aimed to be solved is to verify how the diversification of activities in commercial banks into non-interest products (i.e. trading, securities-based investment activities, and derivatives) brings positive effects such as income stabilization and risk reduction. We examine the implications of banks' risk adjusted ROA that manifest themselves as spreading and growing instability.

Research methodology: We use a panel regression model, through a dataset that covers 777 international banks, in 91 selected countries of the world, spanning the period of 1996–2015.

Results: We document that the diversification of a bank's operations is varied and depends on a bank's characteristics, including asset size.

Novelty: The study contributes to the on-going discussion on the separation of retail and investment banks with a view to enhancing their profit stability.