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.

This paper investigates whether or not functionally diversified banks have a comparative advantage in terms of long-term performance/risk profile compared to their specialized competitors. To that end, this study uses market-based measures of return potential and bank risk. We calculate the franchise value over time of European banks as a measure of their long-run performance potential. In addition, we measure risk as both the systematic and the idiosyncratic risk components derived from a bank stock return model. Finally, we analyze the return/risk trade-off implied in different functional diversification strategies using a panel data analysis over the period 1989–2004. A higher share of non-interest income in total income affects banks’ franchise values positively. Diversification of revenue streams from distinct financial activities increases the systematic risk of banks while the effect on the idiosyncratic risk component is non-linear and predominantly downward-sloping. These findings have conflicting implications for different stakeholders, such as investors, bank shareholders, bank managers and bank supervisors.

We analyze how time-varying bank-specific capital requirements affect bank lending to the non-financial corporate sector as well as banks' balance sheet adjustments. To do so, we relate Pillar 2 capital requirements to a comprehensive corporate credit register coupled with bank and firm balance sheet data. Our analysis consists of three components. First, we investigate how capital requirements affect the supply of bank credit to the corporate sector, both on the intensive and extensive margin, as well as for different types of credit. Subsequently, we document how bank and firm characteristics as well as the monetary policy stance impact the relationship between bank capital requirements and the supply of credit. Finally, we examine how time-varying bank-specific capital requirements affect banks' balance sheet composition.

This paper investigates how stock market investors perceive the impact of market structure and efficiency on the long-run performance potential of European banks. To that end, a modified Tobin’s Q ratio is introduced as a measure of bank franchise value. This measure is applied to discriminate between the market structure and efficient-structure hypotheses in a coherent forward-looking framework, in which differences in banks’ horizontal and vertical differentiation strategies are controlled for. The results show that banks with better management or production technologies possess a long-run competitive advantage. In addition, bank market concentration does not affect all banks equally. Only the banks with a large market share in a concentrated market are able to generate non-competitive rents. The paper further documents that the forward-looking, long-run perspective and the noise-adjustment of the performance measure overcome most of the drawbacks associated with testing these hypotheses in a multi-country set-up. Finally, notwithstanding the international expansion of bank activities, the harmonization of regulation and the macroeconomic convergence in the European Union (EU15), we still find that country-specific macroeconomic variables have a significant impact on bank performance. The findings indicate that there is a trade-off between competition and stability that should be taken into account when assessing mergers or acquisitions.

We show that the effect of non-interest income on systemic risk exposures varies with bank size and a country’s institutional setting. Non-interest income reduces large banks’ systemic risk exposures, whereas it increases that of small banks. However, exploiting heterogeneity in countries’ institutional setting, we show that the bright side of innovation by large banks (lower systemic risk exposure for diversified banks) disappears in countries with more private and asymmetric information, more corruption and in concentrated banking markets. These empirical findings provide support for Saunders and Cornett (2014) who hypothesize which institutional features make the materialization of conflicts of interest more likely.

This paper uses Bayesian Model Averaging to examine the driving factors of equity returns of US Bank Holding Companies. BMA has as an advantage over OLS that it accounts for the considerable uncertainty about the correct set (model) of bank risk factors. We find that out of a broad set of 12risk factors only the market, real estate, and high-minus-low Fama–French factors are reliably related to US bank stock returns over the period 1986–2010. Other factors are either only relevant over specific subperiods or for subsets of bank holding companies. We discuss the implications of our findings for empirical banking research.

This paper addresses the pass-through from market interest rates to retail bank interest rates. The paper advocates a heterogeneous approach and applies it to the Belgian banking market. A substantial proportion of the heterogeneity in bank pricing policies can be explained by the bank lending channel and the relative market power hypothesis. The results also suggest that the long-term pass-through is typically less than one-for-one, rejecting the completeness hypothesis. While there is no convincing evidence for asymmetry in retail rates, large deviations from equilibrium mark-ups are faster reduced than small deviations. Overall, conditions for corporate loans are more competitive compared to consumer loans. Demand and savings deposits have, by far, the most rigid prices.

Frictions prevent banks to immediately adjust their capital ratio towards their desired and/or imposed level. This paper analyzes (i) whether or not these frictions are larger for regulatory capital ratios vis-à-vis a plain leverage ratio; (ii) which adjustment channels banks use to adjust their capital ratio; and (iii) how the speed of adjustment and adjustment channels differ between large, systemic and complex banks versus small banks. Our results, obtained using a sample of listed banks across OECD countries for the 2001–2012 period, bear critical policy implications for the implementation of new (systemic risk-based) capital requirements and their impact on banks’ balance sheets, specifically lending, and hence the real economy.