Toward a More Resilient Financial System: Should Banks Be Diversified?

Abstract

This article empirically analyzes the effects of revenue diversification on the profitability and risk of a large sample of Eurozone banks over the period from 2000 to 2012. We use the generalized method of moments (GMM) estimator, which is also referred to as the system-GMM estimator. We conclude that higher income diversification favors bank profitability. However, our study does not find a significant relationship between revenue diversification and bank risk, even when considering a crisis period. Our results suggest that establishing restrictions in the universal banking model could damage the resilience of the financial system, and thus affect the sustainability of the uneven economic recovery in Europe. other banking activities [9]. The idea of isolating certain types of activities that are considered especially important to the real economy from other riskier, but less important, activities have also been shared by other recent proposals, such as the "Volcker rule" in the United States and the Vickers Commission report in the United Kingdom. These proposals imply restrictions on the universal banking model, in which banks offer a full range of financial services, and thus could lead to less diversified banks [10].This article complements the existing literature in various ways. First, this work contributes to the ongoing debate surrounding bank diversification by focusing on the Eurozone as an interesting case study. Countries in the Eurozone have become increasingly integrated and set apart from other parts of the EU by their economic management since 1999, following the establishment of the euro. Moreover, the sovereign debt crisis in 2010-2011 highlighted the greater interdependence of countries in the monetary union and emphasized the need to create an integrated financial framework to restore confidence in banks and the euro. The Banking Union, which was initiated in 2012 with the agreement on the establishment of a Single Supervisory Mechanism with the involvement of the European Central Bank (ECB), aims to deliver an integrated financial safety net for these countries. Second, the selected time span, from 2000 to 2012, considers the impact of both the 2008 financial crisis and the sovereign debt crisis starting in 2010 in the European banking sector. As the impact of the financial crisis on the real economy has urged policy makers and regulators to drastically change the "rules of the game" by proposing limits to banking activities, it is important to provide further insights into the effect of revenue diversification on bank performance. Most studies have provided evidence of the effect of revenue diversification under normal economic conditions ([11-13] among others). Third, we use a proxy for revenue diversification that reflects the balance of different types of income (interest, net commissions, trades, and other operating income). Finally, we use the generalized method of moments (GMM) estimator, which was developed for dynamic panel models by Arellano and Bover [14] and Blundell and Bond [...

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