Bank Profitability and Financial Stability

TengTeng Xu, Kun Hu and Udaibir Das

No 2019/005, IMF Working Papers from International Monetary Fund

Abstract: 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.

Keywords: WP; bank profitability; price-to-book ratio; math display; Finanical stability; systemic risk; non-interest income; business model; panel regression; NII activity; idiosyncratic risk; problem loan ratio; default probability; charter value; objective function; Bank soundness; Financial sector stability; Vector autoregression; Global (search for similar items in EconPapers)
Pages: 54
Date: 2019-01-11
New Economics Papers: this item is included in nep-ban and nep-rmg
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Citations: View citations in EconPapers (29)

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