07 December 2012

Bundesbank: Which banks are more risky? The impact of loan growth and business model on bank risk-taking

In contrast to the literature on this issue which mainly focuses on large and listed banks, he includes a large number of smaller unlisted banks in his sample which represent the majority of banks in the EU. He thinks that this is important for the broader applicability of the results. He also thinks that this sample should allow better identification of the effects of loan growth and banks’ business models on bank risk, since unlisted differ markedly in their lending behavior and business model from listed banks.

Controlling for endogeneity, bank-, year- and country-specific effects, it is important to enlarge the number of banks and bank types to come to general conclusions about the effect of banks’ business model on risk-taking in the EU banking sector. While the previous studies suggest that it may be beneficial for banks to reduce their share of non-interest income, his results indicate the opposite. This finding is consistent with the common view that European banks are better able to exploit the diversification potential of fee-based activities due to their experience with universal banking models than US banks. The diversification effect of a higher share on non-interest income, however, decreases with bank size possibly because larger banks are more likely to be active in volatile and risky trading and off-balance sheet activities such as securitisation that allows them to employ a higher financial leverage than small banks.

Finally, this paper indicates that supervisors should carefully monitor loan growth on the individual level, since high rates of loan growth are associated with of bank risk-taking. Moreover, they should be aware of the development of aggregate credit growth, since these results show that banks reduce their lending standards and become more risky during periods of excessive lending growth at the country level. This even affects those banks that do not exhibit high rates of individual loan growth compared to their competitors. With respect to aggregate credit growth, the paper provides support for the introduction of countercyclical capital buffers which should reduce credit growth and the build-up of systemic risk during booms.

Discussion paper

© Deutsche Bundesbank