Bank Profitability and Financial Stability

January 11, 2019

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TengTeng Xu, Kun Hu, and Udaibir S Das. Bank Profitability and Financial Stability, (USA: International Monetary Fund, 2019) accessed December 22, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We analyze how bank profitability impacts financial stability from both theoretical and empirical perspectives. We first develop a theoretical model of the relationship between bank profitability and financial stability by exploring the role of non-interest income and retail-oriented business models. We then conduct panel regression analysis to examine the empirical determinants of bank risks and profitability, and how the level and the source of bank profitability affect risks for 431 publicly traded banks (U.S., advanced Europe, and GSIBs) from 2004 to 2017. Results reveal that profitability is negatively associated with both a bank’s contribution to systemic risk and its idiosyncratic risk, and an over-reliance on non-interest income, wholesale funding and leverage is associated with higher risks. Low competition is associated with low idiosyncratic risk but a high contribution to systemic risk. Lastly, the problem loans ratio and the cost-to-income ratio are found to be key factors that influence bank profitability. The paper’s findings suggest that policy makers should strive to better understand the source of bank profitability, especially where there is an over-reliance on market-based non-interest income, leverage, and wholesale funding.

Subject: Bank soundness, Banking, Econometric analysis, Financial crises, Financial sector policy and analysis, Financial sector stability, Systemic risk, Vector autoregression

Keywords: Bank profitability, Bank soundness, Business model, Charter value, Default probability, Financial sector stability, Finanical stability, Global, Idiosyncratic risk, Math display, NII activity, Non-interest income, Objective function, Panel regression, Price-to-book ratio, Problem loan ratio, Systemic risk, Vector autoregression, WP

Publication Details

Pages:

54
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/005
Stock No:

WPIEA2019005
ISBN:

9781484390078
ISSN:

1018-5941

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