Diversification and bank profitability: a nonlinear approach

Abstract

Using information on 98 internationally active banks headquartered in 27 countries over the period 1994–2012, we analyse the nonlinear link between income diversification (defined as noninterest income to total income) and bank return on assets (ROA). The main result is that income diversification is positively correlated with bank profitability only up to a certain degree (30% of the diversification ratio). Diversification benefits for global systemically important banks (GSIBs) are less sizable and significant, especially when we use volatility-adjusted return as a measure of bank profitability.

Keywords:

• regulation
• income diversification
• economies of scope
• global systemically important banks

JEL Classification:

• G21
• G28

Acknowledgements

We would like to thank Kostas Tsatsaronis and Adrian van Rixtel for helpful comments and suggestions. The views expressed here are those of the authors and do not necessarily reflect those of the BIS.

Notes

¹ Due to some limitation in data availability over the time horizon 1994–2012, we consider only 26 out of the 28 GSIBs. For more information see http://www.financialstabilityboard.org/publications/r_121031ac.pdf.

² Similar results are obtained by using as an alternative measure of profitability the return on equity (ROE) instead of the ROA and splitting the sample in pre-crisis and after crisis periods. For more details see Gambacorta and van Rixtel (2013).

³ ROA SE is calculated recursively using information on ROA for the previous 4 years. Results do not change, extending the horizon for the calculation of the SE based on the previous 6 or 8 years.