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Bank Activity and Funding Strategies: The Impact on Risk and Return

  • Demirguc-Kunt, Asli
  • Huizinga, Harry

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7170.

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Date of creation: Feb 2009
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Handle: RePEc:cpr:ceprdp:7170
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