Bank Profitability and Financial Stability

Abstract

We analyze how bank profitability impacts financial stability from both theoretical and empirical perspectives. We first develop a theoretical model of the relationship between bank profitability and financial stability by exploring the role of non-interest income and retailoriented business models. We then conduct panel regression analysis to examine the empirical determinants of bank risks and profitability, and how the level and the source of bank profitability affect risks for 431 publicly traded banks (U.S., advanced Europe, and GSIBs) from 2004 to 2017. Results reveal that profitability is negatively associated with both a bank's contribution to systemic risk and its idiosyncratic risk, and an over-reliance on noninterest income, wholesale funding and leverage is associated with higher risks. Low competition is associated with low idiosyncratic risk but a high contribution to systemic risk. Lastly, the problem loans ratio and the cost-to-income ratio are found to be key factors that influence bank profitability. The paper's findings suggest that policy makers should strive to better understand the source of bank profitability, especially where there is an over-reliance on market-based non-interest income, leverage, and wholesale funding. JEL Classification Numbers: G10, G20 and C23.

Integration Among US Banks

“…The net interest margin is a proxy for bank profitability. To the extent that it has a significant negative association with integration; among otherwise two equivalent banks, the one with more net interest margin may be interpreted to be governed more by idiosyncratic, bank-specific factors (Xu et al, 2019). Finally, Laeven et al (2015) demonstrate that systemic risk varies inversely with bank capital, leading to a possibly negative relationship between integration and the combined tier 1 and 2 capital ratio.…”

“…According to Poirson and Schmittmann (2013) the net interest margin (NIM)-the difference between total interest income and total interest expenses-is a proxy for bank profitability, which they show is positively associated with bank beta, suggesting that all else equal, more profitable banks may have a positive influence on integration. On the other hand, insofar as bank profitability is dependent on bankspecific management practices and corporate governance which are idiosyncratic, one should expect a negative relationship between NIM and bank integration (Xu et al, 2019). Hence, overall, we are agnostic about the presumed effect of NIM on bank integration.…”

Integration Among US Banks

“…are found to affect bank performance and its interconnectivity in Beltratti and Stulz (2012), Adrian and Shin (2010) and Kalemli-Ozcan et al (2012). Among other characteristics, Poirson and Schmittmann (2013) and Xu et al (2019) find that profitability impacts bank stability; Laeven et al (2015) show the effect of capital adequacy ratios on systemic risk; and Cornett et al (2011) andHuang andRatnovski (2011) investigate the role played by banks' reliance on deposit financing in enhancing banks' resilience during crises.…”

Ecuador: La prudencia financiera de la banca privada en dolarización (2001-2019)

“…El bajo desarrollo financiero de estos países se conjuga con la naturaleza de orden privado de los bancos, lo que justificaría la intervención del Estado. Xu et al, (2019) identifican una relación inversa entre la rentabilidad bancaria y su contribución a la toma de riesgo (ver tabla 1 del anexo digital); 2 cada vez que la rentabilidad aumenta, las entidades financieras están menos dispuestas a tomar mayores riesgos. Saona (2016), en cambio, mide la relación entre el riesgo de crédito y la rentabilidad y expresa que es directa.…”

“…Se precisó en el marco teórico que el incumplimiento del prestatario se mide a través del riesgo de crédito. De esta manera, los trabajos de Vera et al (2019), Xu et al (2019), Saona (2016) y Petria et al (2015) establecieron como riesgo de crédito a la provisión de las carteras de créditos. Para evaluar qué tan prudente o conservadora es la banca privada en Ecuador, primero se medirá el riesgo de crédito bajo un enfoque ex ante, a través de las provisiones generadas.…”