March 2008 working paper no. 330 Issn 1975-5163 Joon-Ho Hahm
Homogeneity in Bank Revenue Structure and Macroeconomic Volatility
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Non-Interest Income of Commercial Banks
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- . Summary and Conclusion
4. Homogeneity in Bank Revenue Structure and Macroeconomic Volatility
As discussed in the literature review above, financial consolidation and conglomeration may increase systemic risk potential because, although the extent of diversification can increase at individual banks, large banks tend to share increasingly similar characteristics in their business portfolios and asset structures. This section focuses on the degree of homogeneity in bank revenue structure across banks within countries and explores its implication on macroeconomic volatility. More specifically, we estimate the following simple cross-country regressions: j j j j j MCF SDNIIR AVNIIR MCV ' (3) Where MCV j is a macroeconomic volatility variable for country j. The macroeconomic volatility variables are measured using the standard deviations of inflation, real GDP growth, the ratio of stock market capitalization to GDP, and real interest rate. AVNIIR is the time-average of mean non-interest income ratio across banks in a given country and SDNIIR is the time-average of the standard deviation of the non-interest income ratio across banks in that country. In other words, AVNIIR is constructed by computing the average NIIR across banks for each year, and then taking average across the time period (1992-2006). Hence, it denotes the degree of revenue diversification toward non-interest 22 income for each country. Likewise, SDNIIR is constructed by taking average of yearly standard deviations in non-interest income ratios across banks, and denotes the degree of heterogeneity in bank revenue structure within that country. We test the impact of the average level of non-interest income as well as the heterogeneity of non-interest income ratios on macroeconomic volatilities by including macroeconomic indicators as controlling variables. Table 6 reports OLS estimation results for regression (3). Note that the inflation rate is significantly positively associated with its own volatility as well as real interest rate volatility. The stock market capitalization to GDP ratio is also positively correlated with its own volatility. As for the commercial bank non-interest income ratio, the average level itself does not seem to be significantly associated with macroeconomic volatilities. Note however that, the standard deviation of non-interest income ratios across banks is significantly negatively associated with the standard deviation of the inflation rate whether or not other macroeconomic volatilities are included as additional control variables. Hence, we may conclude that increasingly homogeneous bank revenue structure tends to be associated with higher inflation volatility; potentially through higher indirect interdependence and herd behavior among banks. As banks share a common revenue structure, they may respond to shocks in an increasingly similar manner, thereby causing higher inflation volatility. 23 Ⅳ. Summary and Conclusion This paper investigated potential determinants and consequences of the changing revenue structure of commercial banks in the era of financial deregulation and conglomeration. Utilizing a firm-level dataset of 662 commercial banks from 29 OECD countries, we found several interesting empirical patterns, which can be summarized as follows: First, we investigated the factors that influence banks’ choice of the degree of non- interest income diversification. We found that, in addition to bank specific factors such as total asset size, equity-asset ratio, and net interest margin, macroeconomic factors such as real GDP growth, inflation rate, and stock market capitalization are potentially important determinants of bank non-interest income shares. Commercial banks in countries with slow economic growth, a stable inflation environment, and well-developed capital markets tend to have higher non-interest income shares. Second, we investigated potential impacts of rising non-interest income shares on bank profitability and risks. We found that banks with higher non-interest income shares tend to exhibit a higher return on assets as well as higher equity-asset ratios. However, these banks also exhibit higher variances in return on assets. Consequently, diversification toward non-interest income does not seem to exert a significant impact on bank insolvency risk as measured by z-score. Namely, both the sum of earnings and capital, and 24 earnings variability seem to increase simultaneously without affecting net insolvency risk of banks. Finally, financial consolidation and conglomeration give rise to the emergence of a few large, complex banking organizations with increasingly similar business portfolios and asset structure, thereby raising systemic risk concerns. In this paper, we also studied macroeconomic implications of the increasing degree of homogeneity in revenue structure across banks within countries. We found that countries with more heterogeneous bank revenue structure tend to show lower inflation volatility, although there seem to be no significant impacts on real GDP growth or real interest rate volatilities. In sum, overall findings of the present paper suggest that expanding non-interest income businesses is not the panacea for commercial banks in the face of increased competition. Business diversification may not produce desired income diversification effects, and it does not necessarily imply a shift toward superior return-risk frontiers. Furthermore, at the macroeconomic level, excessive convergence in the revenue structure of banks may potentially undermine macroeconomic stability. Just as diversification may help stabilize earnings at the firm level, diversification across banks may be desirable at the macroeconomic level. |
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