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The universal bank model: Synergy or vulnerability?

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Abstract

In this paper, we examine the costs and benefits of diversification and expansion into non-traditional activities on the bank level. Using detailed information on the US banking sector over the period 2002–2012, we investigate whether or not banks’ involvement in various business lines has been associated with higher risks and returns. Using cross-sectional analysis, we find evidence that banks’ expansion into non-traditional activities has lacked revenue and diversification benefits: The overall risks of non-traditional banks have been higher, while returns were not. A higher degree of diversification across traditional and certain non-traditional activities, on the contrary, has been associated with higher returns and risk-reduction benefits. The results thus indicate that diversification prior to the financial crisis proved effective in the crisis environment, whereas too high involvement in non-traditional businesses did not. These results hold for small and large banks, banks of different tax status and various profitability and risk measures.

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Notes

  1. See also the Volcker rule, Liikanen report and Vickers report.

  2. For example, providing insurance and asset management services through an existing retail bank branch network might be associated with cost economies of scope. Such cross-selling of products can in turn generate revenue economies of scope implied by consumption complementarities (“one-stop shopping” convenience), which reduce consumers search and transaction costs and increase a bank’s ability to underprice competitors.

  3. The pro-forma statements are calculated by the sum of the individual statements of banks that belong to the same ultimate holder.

  4. We excluded banks with a lifespan of less than 12 quarters. Due to the large number of changes in the ultimate holding company, we required in addition that the aggregated pro-forma bank has been active for at least 12 quarters. Finally, foreign-owned banks and banks controlled by non-financial entities have been excluded, because of the lack of data on the holding company.

  5. We excluded banks with a lifespan of less than 12 quarters. Due to the large number of changes in the ultimate holding company, we required in addition that the aggregated pro-forma bank has been active for at least 12 quarters. Finally, foreign-owned banks and banks controlled by non-financial entities have been excluded, because of the lack of data on the holding company.

  6. Historically, the universal bank model has been more common in Europe compared to the United States [32, 33]. From the Great Depression until the late 1980s, banks’ activities have been largely restricted. Only over time, banks activity restrictions have been removed as with the Gramm–Leach–Bliley Act (GLBA) of 1999 [20, 34, 35].

  7. We have as well experimented with asset diversification. We prefer however this measure, since Fee-for-Service activities are not readily displayed in the balance sheet, as they involve in many cases contingent off-balance sheet positions or intangible assets such as human capital and non-financial assets like information technology [30, 31].

  8. It could be argued that the unconditional volatility of profits is not an appropriate measure of bank risk, because financial markets allow banks and investors to diversify and hedge idiosyncratic risks. One could of course examine equity market returns and their implied volatility with the advantage that these indicators are forward-looking, but with the caveat of limiting the study to a much smaller sample of publicly traded and large banks [24, 31]. Moreover, the return on equity and its volatility are important indicators that are used by regulators, managers and shareholders to assess the performance and soundness of financial institutions. It could also serve as a criterion in performance-based remuneration schemes for bank managers.

  9. For instance, while positive shocks to interest income would, ceteris paribus, reduce the non-traditional income share (by increasing the denominator) and increase profits, positive shocks to non-interest income would be associated with increases in the non-traditional income share (through the numerator) and higher bank profits.

  10. We removed outliers and excluded observations in the first and last percentile of the distribution of the return on equity.

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Acknowledgements

We would like to thank the Editor Professor Singh, an anonymous referee, Michel Boutillier, Elena Dumitrescu, Adam Gersl, Bertand Groslambert, Mathias Lé, Matthias Köhler, Laurence Scialom, Alfredo Schclarek, Tatiana Yongoua and the participants of the 5th International Conference of the Financial Engineering and Banking Society, 32nd International Symposium on Money, Banking and Finance, and the Financial Intermediation Seminar at University Paris Nanterre for valuable and helpful comments. All remaining errors are ours.

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Authors and Affiliations

  1. School of Finance and Economics, Jiangsu University, Zhenjiang, China

    Xi Yang

  2. EconomiX-CNRS, Université Paris Nanterre, Nanterre, France

    Xi Yang

  3. LEM-CNRS, Faculté des Sciences Economiques et Sociales, Université de Lille, Lille, France

    Michael Brei

  4. Department of Economics, The University of the West Indies, Cave Hill, Barbados

    Michael Brei

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Correspondence to Xi Yang.

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Appendix

Appendix

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Table 6 Definition of variables
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Yang, X., Brei, M. The universal bank model: Synergy or vulnerability?. J Bank Regul 20, 312–327 (2019). https://doi.org/10.1057/s41261-019-00096-y

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