The change in banks' product mix, diversification and performance: An application of multivariate GARCH to Canadian data

Data suggest a change in banks’ performance attributable to a greater involvement in non-traditional activities. Indeed, market-oriented banking increases banks’ accounting returns at the cost of a higher volatility in financial results. The motivation of this paper is to study how bank product mix impacts diversification and performance. Thanks to our data and methodology we are able to shed new light on the apparently contradictory results found in the literature regarding the benefits to diversify in market-based banking. Some keys conditional volatilities reveal these benefits may in fact vary both over the business cycles and through time. Using a new framework based on a multivariate GARCH procedure and a modified Hausman test, our main findings suggest that most components of non-interest income actually provide non-negligible diversification benefits with respect to traditional banks’ business lines. In normal times, diversification even works for the components most related to market-oriented banking, i.e., trading income and capital markets fees. Not so surprisingly however, during crisis episodes these diversification benefits seem to vanish for most of the components, except for insurance and securitization, which act as buffers. Consistent with the literature, we also find that, despite the evolution of the banking business model, fees related to banks’ traditional activities – deposit, credit card and loan fees – remain the most stable and profitable sources of income.