Banks’ earnings: Empirical evidence of the influence of economic and financial market factors

Date01 April 2018
DOIhttp://doi.org/10.1016/j.rfe.2017.09.001
Published date01 April 2018
AuthorHervé Alexandre,Stéphane Albert
ORIGINAL ARTICLE
Banksearnings: Empirical evidence of the influence of
economic and financial market factors
St
ephane Albert
1
|
Herv
e Alexandre
2
1
Universit
e Paris 1, 12, place du
Panth
eon, 75231 Paris cedex 05, France
2
DRM, CNRS, [UMR 7088], Universit
e
Paris-Dauphine, PSL Research
University, 75016 Paris, France
Correspondence
Herv
e Alexandre, DRM, CNRS, [UMR
7088], Universit
e Paris-Dauphine, PSL
Research University, 75016 Paris, France.
Email: herve.alexandre@dauphine.fr
Abstract
The structure of income is a foremost address within research on banksperfor-
mance, especially with regard to effects on the resilience of banksearnings.
Indeed, given their central position in the economy, banks shall thrive to generate
sustainable earnings and control for their potential volatility. Existing studies
mostly consider the weight of non-net interest income (nonNII) as opposed to the
traditional NII income source. Such aggregated nonNII is found to increase earn-
ings risk but more granular studies conflict. We propose an original investigation
of the influence of economic and financial conditions on various income types,
assuming that performance may actually be driven by both the income structure
and external conditions.
We focus European banks, which have long been allowed to diversify beyond
retail banking. Out of a straight panel framework, we question if the influence of
external conditions spreads to earnings components other than credit losses and
trading income and if it does allow for diversification benefits among compo-
nents. We find that each component actually evolves owing to its own equation.
Furthermore, effects of single variables may cumulate over different components
of earnings (e.g. GDP) or provide with diversification benefits. These effects are
all the more important since they are not mitigated by operating expenses. Hence,
over a regarded period, banksperformance depends upon their structure of
income and upon volatilities and correlations of influential variables. Besides con-
trolling for ex-ante volatility, our approach shows that a given structure of income
is not necessarily more resilient than others but that selected non-banking income
may support a higher stability of Earnings
JEL CLASSIFICATION
G21, G28, L25
KEYWORDS
Bank performance, Diversification, Earnings resilience, Interest rate mismatch, Risk factors
First published online by Elsevier on behalf of The University of New Orleans, 8 September, 2017, https://doi.org/10.1016/j.rfe.2017.09.001
Received: 17 February 2016
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Revised: 26 April 2017
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Accepted: 3 September 2017
DOI: 10.1016/j.rfe.2017.09.001
Rev Financ Econ. 2018;36:97116. wileyonlinelibrary.com/journal/rfe ©2017 The University of New Orleans
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97
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INTRODUCTION
Due to the central position of banks within the financial system and therefore the economy, their performance is under spe-
cial scrutiny by public authorities (e.g. dedicated supervisors) and by financial research. One of the leading matters relates
to the volatility of their earnings with regard to the business model they operate and therefore to their incom e structure.
Since the 1990s, research on banksperformance has intensified given their diversification into non-banking activiti es. Par-
ticularly in Europe, banks have developed a more universal model. They expanded into financial servi ces for customers
(e.g. brokerage, custody and management of customerssecurities or mutual funds) or into proprietary financial activities
such as trading. Revenues from non-banking activities primarily materialize in non-interest income (nonNII) whereas net
interest income (NII) is usually associated with more traditional banking services. Data from OECD Banking Statistics evi-
dence the change in the structure of income of European banks over the last decades (Fig. 1). An increasing weight of non-
NII can be observed. The ratio was 26% in 1988 and increased up to 74% in 2000 and 89% in 2006 prior to the crisis. The
ratio of nonNII over customer loans (Fig. 2) was almost twice as high in 2000 as compared to 1988 (2.3% versus 1.3%)
while proving volatile later on. Yet, the ratio of NII over customer loans has been steadily and markedly decreasing
(Fig. 2).
However the effects of income diversification on the performance of banks remain to be further explored (Acharya, Hasan,
& Saunders, 2006; Laeven & Levine, 2007). Kuritzkes and Schuermann (2010) also report that business risk (income stem-
ming from customer-oriented activities) as well as interest rate risks (non-trading) can have a large impact on earnings and
require further investigations. Existing studies dominantly conclude that nonNII is more volatile than NII and increases the
volatility of total earnings. However nonNII encompasses a variety of income sources and more granular investigations within
nonNII are scarce and little conclusive to date. Further, they focus on income and do not explicitly consider loan losses or
costs. Reported findings may also be influenced by the regarded periods. Although such influence of the economic and finan-
cial environment is commonly known and reported for aggregated earnings by working papers from banking supervisors, it
has been addressed for sub-types of income in a very limited set of academic research (e.g. Albertazzi & Gambacorta, 2009).
Since 1988, the international banking prudential regulation, namely the Basle accords, has supported a level-playing
field among banks from different countries. The Basle regulation does not explicitly address the income structure of banks
but, rather, imposes requirements for banksown funds versus the risk of their assets (risk-weighted assets). Among other
new requirements e.g. on liquidity and funding, the international Basel III Acco rds (2011) require banks to gradually
increase their equity base by 2019. Both in the US and in Europe, new mechanisms for orderly bank resolutionalso
enable authorities to restructure a banks debt prior to a potential default. Such mechanisms involve inst itutional investors
as well as large depositors not covered by guarantee schemes. The vigilance of bankscounterparts (market discipline in
the sense of Calomiris, 1999) shall increase. Since earnings are the prime source of new equity, especially in more adverse
market conditions, banks need to control for such volatility when growing their asset s or, more generally, their business.
This new environment increases the need to under- stand risks associated with banksearnings and to adopt a forward-
looking approach.
Based on a panel of 263 European banks with data between 2005 and 2010, the present study proposes to explore the
sensitivity of various income sources to economic and financial conditions. The choice of using data up to 2010 is moti-
vated by the fact that first Basle III announcements occurred in 2010. Relate d regulatory requirements are still in
0,15
0,25
0,35
0,45
0,55
0,65
0,75
0,85
0,95
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
FIG. 1 Ratio of non-net interest income over net-interest income. Sum of banks for Germany, France, Italy, Spain, Netherlands and Belgium
Source: OECD Statistics (available up to 2009) and computations of authors.
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ALBERT AND ALEXANDRE

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