The rise of shadow banking and the hidden benefits of diversification
AbstractThe diversification benefits associated with banks off-balance-sheet activities (OBS), and particularly non- traditional activities, is a question much debated in the literature. These activities, related to the emergence of shadow banking, greatly contribute to the volatility of bank operating revenues, but their impact on accounting returns is less clear (Stiroh and Rumble 2006). In this paper, we use a Canadian dataset to revisit the risk-return trade-off associated with banks OBS activities and study the evolution of the endo-geneity of banks decision to expand their market-oriented business lines. Consistent with the changing mix of noninterest income OBS activities generate, we identify a structural break in 1997 which coincides with an increased impact of endogeneity on banks returns, and which also leads to an increased return on assets (ROA) and a surge in banking risk. We trace the sources of the greater volatility of noninterest income to a tighter cointegrating relationship between noninterest income and stock market indices after 1997. Intro-ducing a new, robust estimation method based on a modification of the Hausman procedure, we find that neglecting endogeneity greatly underestimates the positive impact of shadow banking on bank accounting returns, even when the subprime crisis is considered. Our main results suggest that the influence of market-based activities on the risk-return trade-off might be larger than what was previously thought.
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Bibliographic InfoPaper provided by Département des sciences administratives, UQO in its series RePAd Working Paper Series with number UQO-DSA-wp042011.
Length: 55 pages
Date of creation: 11 Apr 2011
Date of revision:
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Noninterest income; Hausman test; Structural break; Shadow Banking; Endogeneity.;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- G20 - Financial Economics - - Financial Institutions and Services - - - General
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-05-30 (All new papers)
- NEP-BAN-2011-05-30 (Banking)
- NEP-BEC-2011-05-30 (Business Economics)
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