Back to the basics in banking? A micro-analysis of banking system stability

Research output: Contribution to journalArticleScientificpeer-review

Abstract

This paper analyzes the relationship between banks’ divergent strategies toward specialization and diversification of financial activities and their ability to withstand a banking sector crash. We first generate market-based measures of banks’ systemic risk exposures using extreme value analysis. Systemic banking risk is measured as the tail beta, which equals the probability of a sharp decline in a bank’s stock price conditional on a crash in a banking index. Subsequently, the impact of (the correlation between) interest income and the components of non-interest income on this risk measure is assessed. The heterogeneity in extreme bank risk is attributed to differences in the scope of non-traditional banking activities: non-interest generating activities increase banks’ tail beta. In addition, smaller banks and better-capitalized banks are better able to withstand extremely adverse conditions. These relationships are stronger during turbulent times compared to normal economic conditions. Overall, diversifying financial activities under one umbrella institution does not improve banking system stability, which may explain why financial conglomerates trade at a discount.
Original languageEnglish
Pages (from-to)387-417
JournalJournal of Financial Intermediation
Volume19
Issue number3
DOIs
Publication statusPublished - 2010

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Banking
Banking system
Crash
Banking risk
Financial conglomerates
Risk measures
Bank relationships
Extreme values
Income
Stock prices
Diversification
Bank risk
Discount
Systemic risk
Value analysis
Non-interest income
Risk exposure
Nontraditional
Economic conditions
Banking sector

Cite this

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title = "Back to the basics in banking? A micro-analysis of banking system stability",
abstract = "This paper analyzes the relationship between banks’ divergent strategies toward specialization and diversification of financial activities and their ability to withstand a banking sector crash. We first generate market-based measures of banks’ systemic risk exposures using extreme value analysis. Systemic banking risk is measured as the tail beta, which equals the probability of a sharp decline in a bank’s stock price conditional on a crash in a banking index. Subsequently, the impact of (the correlation between) interest income and the components of non-interest income on this risk measure is assessed. The heterogeneity in extreme bank risk is attributed to differences in the scope of non-traditional banking activities: non-interest generating activities increase banks’ tail beta. In addition, smaller banks and better-capitalized banks are better able to withstand extremely adverse conditions. These relationships are stronger during turbulent times compared to normal economic conditions. Overall, diversifying financial activities under one umbrella institution does not improve banking system stability, which may explain why financial conglomerates trade at a discount.",
author = "{De Jonghe}, O.G.",
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}

Back to the basics in banking? A micro-analysis of banking system stability. / De Jonghe, O.G.

In: Journal of Financial Intermediation, Vol. 19, No. 3, 2010, p. 387-417.

Research output: Contribution to journalArticleScientificpeer-review

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