The expansion of services in European banking: Implications for loan pricing and interest margins

Abstract

International audienceOur study of 602 European banks over 1996-2002 investigates how the banks' expansion into fee-based services has affected their interest margins and loan pricing. We find that higher income share from commissions and fees is associated with lower margins and loan spreads. The higher the commission and fee income share, moreover, the weaker the link between bank loan spreads and loan risk. The latter result is consistent with the conjecture that banks price (or misprice) loans to increase sales of other services. That loss leader (or cross selling) hypothesis has implications for bank regulation and competition with (non-bank) lenders

Income Diversification in the German Banking Industry

“…Conversely, revenue shares of fees received for off-balance sheet facilities and fiduciary activities do not seem to have any influence on risk and return, possibly on account of the relatively small share of this income category. Lepetit et al (2008) find that in the case of 602 European banks during the period 1996-2002 there was a negative correlation between interest margin and non-interest income. The authors assume that banks use loans as a loss leader to expand their non-interest income via cross-selling.…”

“…This relationship is justified by possible cross-subsidization (or cross-selling) effects, as banks might just charge a lower interest margin when they expect increased revenues from fees and commissions in the non-interest business (Lepetit et al, 2008). To analyze possible cross-subsidization effects between interest and fee income in the German banking industry we specify a bank loan pricing model.…”

Non‐interest Income, Profit, and Risk Efficiencies: Evidence from Commercial Banks in China

“…Mercieca et al (2007) focuses on small-sized banks in 15 member nations of the European Union from 1997 to 2003 and show that increased non-interest income is positively related to profitability proxied by ROA (Return on Assets) and ROE (Return on Equity), but is negatively related to risk-adjusted profitability and increased insolvency risk. Lepetit et al (2008) also shows that higher non-interest income is associated with higher risk, but this relationship is stronger for commission and fee income than for trading income. In contrast, Chiorazzo et al (2008) use data from 85 Italian banks during 1993 to 2003 and show that increased non-interest income is positively related to risk-adjusted profits.…”

“…First, although many studies investigate the relationship among commercial banks' non-interest income, profitability, and risk using financial ratios (DeYoung and Rice, 2004;Stiroh, 2004;Lepetit et al, 2008), few papers examine the extent to which non-interest income businesses affect profit and risk efficiencies. Since the seminar paper by Aigner et al (1977), stochastic frontier analysis measuring efficiency has become state-of-the-art for comparing the performance of production units.…”

“…Stiroh and Rumble (2006) use 1997-2002 data from 1800 financial holding companies in the United States and reach similar conclusions. Smith et al (2003), Mercieca et al (2007), Lepetit et al (2008), and Chiorazzo et al (2008) examine the relationship among non-interest income, profit, and risk in European countries but arrive at different results. Smith et al (2003) find that although non-interest income is more volatile than interest income, the correlation between the two is negative.…”