The rise of shadow banking and the hidden benefits of diversification

Christian Calmès () and Raymond Théoret ()
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Raymond Théoret: Chaire d'information financière et organisationnelle ESG-UQAM, Université du Québec (Montréal), Université du Québec (Outaouais)

RePAd Working Paper Series from Département des sciences administratives, UQO

Abstract: The diversification benefits associated with banks off-balance-sheet activities (OBS), and particularly non- traditional activities, is a question much debated in the literature. These activities, related to the emergence of shadow banking, greatly contribute to the volatility of bank operating revenues, but their impact on accounting returns is less clear (Stiroh and Rumble 2006). In this paper, we use a Canadian dataset to revisit the risk-return trade-off associated with banks OBS activities and study the evolution of the endo-geneity of banks decision to expand their market-oriented business lines. Consistent with the changing mix of noninterest income OBS activities generate, we identify a structural break in 1997 which coincides with an increased impact of endogeneity on banks returns, and which also leads to an increased return on assets (ROA) and a surge in banking risk. We trace the sources of the greater volatility of noninterest income to a tighter cointegrating relationship between noninterest income and stock market indices after 1997. Intro-ducing a new, robust estimation method based on a modification of the Hausman procedure, we find that neglecting endogeneity greatly underestimates the positive impact of shadow banking on bank accounting returns, even when the subprime crisis is considered. Our main results suggest that the influence of market-based activities on the risk-return trade-off might be larger than what was previously thought.

Keywords: Noninterest income; Hausman test; Structural break; Shadow Banking; Endogeneity. (search for similar items in EconPapers)
JEL-codes: C32 G20 G21 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2011-04-11
New Economics Papers: this item is included in nep-ban and nep-bec
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Citations: View citations in EconPapers (4)

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