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Income diversification in the German banking industry

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  • Busch, Ramona
  • Kick, Thomas

Abstract

In the last few years it has been possible to observe decreasing interest margins for German universal banks. At the same time, institutions increasingly moved part of their business from interest to fee-earning activities. This study analyzes the determinants of non-interest income and its impact on financial performance and the risk profile of German banks between 1995 and 2007. We find empirical evidence that for all German universal banks risk-adjusted returns on equity and total assets are positively affected by higher fee income activities. Additionally, for commercial banks we show that a strong engagement in fee-generating activities goes along with higher risk. In order to analyze possible cross-subsidization effects between interest and fee business we also examine how banks' expansion in fee-based services has affected their interest margin. For savings and commercial banks we find that institutions with a strong focus on fee business charge lower interest margins when credit risk is controlled. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2009,09.

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Date of creation: 2009
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Handle: RePEc:zbw:bubdp2:200909

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Keywords: Income diversification; interest income; fee income; interest margin; two-stage least squares estimator;

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References

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  1. Evelyn Hayden & Daniel Porath & Natalja von Westernhagen, 2006. "Does Diversification Improve the Performance of German Banks? Evidence from Individual Bank Loan Portfolios," Working Papers 110, Oesterreichische Nationalbank (Austrian Central Bank).
  2. Mitchell Petersen, 2004. "Comment on Stiroh," Journal of Financial Services Research, Springer, vol. 25(2), pages 161-167, April.
  3. Kevin J. Stiroh, 2002. "Diversification in banking: is noninterest income the answer?," Staff Reports 154, Federal Reserve Bank of New York.
  4. Luc Laeven & Ross Levine, 2005. "Is There a Diversification Discount in Financial Conglomerates?," NBER Working Papers 11499, National Bureau of Economic Research, Inc.
  5. Joshua Angrist & Alan B. Krueger, 2001. "Instrumental Variables and the Search for Identification: From Supply and Demand to Natural Experiments," NBER Working Papers 8456, National Bureau of Economic Research, Inc.
  6. Michael Koetter & Thorsten Nestmann & Stéphanie Stolz & Michael Wedow, 2004. "Structures and Trends in German Banking," Kiel Working Papers 1225, Kiel Institute for the World Economy.
  7. Vincenzo Chiorazzo & Carlo Milani & Francesca Salvini, 2008. "Income Diversification and Bank Performance: Evidence from Italian Banks," Journal of Financial Services Research, Springer, vol. 33(3), pages 181-203, June.
  8. repec:fth:prinin:455 is not listed on IDEAS
  9. DeYoung, Robert & Roland, Karin P., 2001. "Product Mix and Earnings Volatility at Commercial Banks: Evidence from a Degree of Total Leverage Model," Journal of Financial Intermediation, Elsevier, vol. 10(1), pages 54-84, January.
  10. Stiroh, Kevin J. & Rumble, Adrienne, 2006. "The dark side of diversification: The case of US financial holding companies," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2131-2161, August.
  11. Christopher F Baum & Mark E. Schaffer & Steven Stillman, 2002. "Instrumental variables and GMM: Estimation and testing," North American Stata Users' Group Meetings 2003 05, Stata Users Group.
  12. Ho, Thomas S. Y. & Saunders, Anthony, 1981. "The Determinants of Bank Interest Margins: Theory and Empirical Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(04), pages 581-600, November.
  13. Campa, Jose M. & Kedia, Simi, 2000. "Explaining the diversification discount," IESE Research Papers D/424, IESE Business School.
  14. von Westernhagen, Natalja & Porath, Daniel & Hayden, Evelyn, 2006. "Does diversification improve the performance of German banks? Evidence from individual bank loan portfolios," Discussion Paper Series 2: Banking and Financial Studies 2006,05, Deutsche Bundesbank, Research Centre.
  15. Neil Esho & Paul Kofman & Ian Sharpe, 2005. "Diversification, Fee Income, and Credit Union Risk," Journal of Financial Services Research, Springer, vol. 27(3), pages 259-281, September.
  16. Lepetit, Laetitia & Nys, Emmanuelle & Rous, Philippe & Tarazi, Amine, 2008. "The expansion of services in European banking: Implications for loan pricing and interest margins," Journal of Banking & Finance, Elsevier, vol. 32(11), pages 2325-2335, November.
  17. Behr, Andreas & Kamp, Andreas & Memmel, Christoph & Pfingsten, Andreas, 2007. "Diversification and the banks' risk-return-characteristics: evidence from loan portfolios of German banks," Discussion Paper Series 2: Banking and Financial Studies 2007,05, Deutsche Bundesbank, Research Centre.
  18. Maudos, Joaquin & Fernandez de Guevara, Juan, 2003. "Factors Explaining the Interest Margin in the Banking Sectors of the European Union," MPRA Paper 15252, University Library of Munich, Germany.
  19. Mercieca, Steve & Schaeck, Klaus & Wolfe, Simon, 2007. "Small European banks: Benefits from diversification?," Journal of Banking & Finance, Elsevier, vol. 31(7), pages 1975-1998, July.
  20. Robert DeYoung & Tara Rice, 2004. "Noninterest Income and Financial Performance at U.S. Commercial Banks," The Financial Review, Eastern Finance Association, vol. 39(1), pages 101-127, 02.
  21. Kevin Stiroh, 2004. "Do Community Banks Benefit from Diversification?," Journal of Financial Services Research, Springer, vol. 25(2), pages 135-160, April.
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Citations

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Cited by:
  1. Köhler, Matthias, 2012. "Which banks are more risky? The impact of loan growth and business model on bank risk-taking," Discussion Papers 33/2012, Deutsche Bundesbank, Research Centre.
  2. Calmès, Christian & Théoret, Raymond, 2010. "The impact of off-balance-sheet activities on banks returns: An application of the ARCH-M to Canadian data," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1719-1728, July.
  3. Ali Osman GURBUZ & Serhat YANIK & Yusuf AYTURK, 2013. "Income Diversification and Bank Performance: Evidence From Turkish Banking Sector," Journal of BRSA Banking and Financial Markets, Banking Regulation and Supervision Agency, vol. 7(1), pages 9-29.
  4. Christian Calmès & Raymond Théoret, 2013. "The change in banks' product mix, diversification and performance: An application of multivariate GARCH to Canadian data," RePAd Working Paper Series UQO-DSA-wp012013, Département des sciences administratives, UQO.
  5. Li, Li & Zhang, Yu, 2013. "Are there diversification benefits of increasing noninterest income in the Chinese banking industry?," Journal of Empirical Finance, Elsevier, vol. 24(C), pages 151-165.
  6. Köhler, Matthias, 2013. "Does non-interest income make banks more risky? Retail- versus investment-oriented banks," Discussion Papers 17/2013, Deutsche Bundesbank, Research Centre.
  7. Christian Calmès & Raymond Théoret, 2009. "Off-Balance-Sheet Activities and the Shadow Banking System: An Application of the Hausman Test with Higher Moments Instruments," RePAd Working Paper Series UQO-DSA-wp042009, Département des sciences administratives, UQO.

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