This paper analyzes the relationship between banks’ divergent strategies toward specialization and diversification of financial activities and their ability to withstand a banking sector crash. We first generate market-based measures of banks’ systemic risk exposures using extreme value analysis. Systemic banking risk is measured as the tail beta, which equals the probability of a sharp decline in a bank’s stock price conditional on a crash in a banking index. Subsequently, the impact of (the correlation between) interest income and the components of non-interest income on this risk measure is assessed. The heterogeneity in extreme bank risk is attributed to differences in the scope of non-traditional banking activities: non-interest generating activities increase banks’ tail beta. In addition, smaller banks and better-capitalized banks are better able to withstand extremely adverse conditions. These relationships are stronger during turbulent times compared to normal economic conditions. Overall, diversifying financial activities under one umbrella institution does not improve banking system stability, which may explain why financial conglomerates trade at a discount.

This paper documents large cross-country variation in the relationship between bank competition and bank stability and explores market, regulatory and institutional features that can explain this variation. We show that an increase in competition will have a larger impact on banks’ fragility in countries with stricter activity restrictions, lower systemic fragility, better developed stock exchanges, more generous deposit insurance and more effective systems of credit information sharing. The effects are economically large and thus have important repercussions for the current regulatory reform debate.

We examine the dynamic behavior of bank capital using a global sample of 64 countries during the 1994–2010 period. Banks achieve deleveraging primarily through equity growth (rather than asset liquidation). In contrast, they achieve leveraging through reduced earnings retention and substantial asset expansion. The speed of capital structure adjustment is heterogeneous across countries. Banks make faster capital structure adjustments in countries with more stringent capital requirements, better supervisory monitoring, more developed capital markets, and high inflation. In times of crises, banks adjust their capital structure significantly more quickly.

Current empirical methods to identify and assess the impact of bank credit supply shocks rely strictly on multi-bank firms and ignore firms borrowing from only one bank. Yet, these single-bank firms are often the majority of firms in an economy and most prone to credit supply shocks. We propose and underpin an alternative demand control (using industry–location–size–time fixed effects) that allows identifying time-varying cross-sectional bank credit supply shocks using both single- and multi-bank firms. Using matched bank-firm credit data from Belgium, we show that firms borrowing from banks with negative credit supply shocks exhibit lower financial debt growth, asset growth, investments, and operating margin growth. Positive credit supply shocks are associated with bank risk-taking behaviour at the extensive margin. Importantly, to capture these effects it is crucial to include the single-bank firms when identifying the bank credit supply shocks.