What question did this study set out to answer?

This research aims to explore the nonlinear relationship between income diversification and bank profitability, measured as return on assets.

January 14, 2014

Diversification and bank profitability: a nonlinear approach

Key Points

This research aims to explore the nonlinear relationship between income diversification and bank profitability, measured as return on assets.
Analyzed data from 98 internationally active banks across 27 countries from 1994 to 2012.
Assessed the correlation between noninterest income to total income ratio and return on assets (ROA).
Considered volatility-adjusted return for global systemically important banks (GSIBs).
Found a positive correlation between income diversification and bank profitability only up to 30% of the diversification ratio.
For GSIBs, diversification benefits were less significant and sizable.
Indicated that profitability is affected differently based on the level of diversification.

Abstract

Using information on 98 internationally active banks headquartered in 27 countries over the period 1994--2012, we analyse the nonlinear link between income diversification (defined as noninterest income to total income) and bank return on assets (ROA). The main result is that income diversification is positively correlated with bank profitability only up to a certain degree (30% of the diversification ratio). Diversification benefits for global systemically important banks (GSIBs) are less sizable and significant, especially when we use volatility-adjusted return as a measure of bank profitability.

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