Nontraditional Banking Activities and Bank Failures During the Financial Crisis

Abstract

There is general agreement among bank researchers that revenues from fee-based activities are more volatile than revenues from more traditional interest-based (loans and deposits) activities. We test whether noninterest income was a determining factor in the hundreds of U.S. commercial bank failures during the financial crisis. We separate noninterest income into three categories: fee income from traditional banking activities like deposit accounts and lines of credit; fee-for-service income from nontraditional activities like brokerage and insurance, and stakeholder income from nontraditional activities that require banks to make asset investments. We find that fee-for-service income significantly and substantially reduced the probability that healthy banks failed or became financially distressed, while stakeholder income significantly and substantially increased the probability that distressed banks failed. These results indicate that the risk-return characteristics of noninterest income vary in idiosyncratic ways that have not been recognized or accounted for in prior research. Our results also suggest that bank capital charges should be larger, and supervisory responses at distressed banks should be prompter, for banks that engage in what we define here as stakeholder activities.

Keywords: Bank failure, nontraditional banking activities, noninterest income

JEL Classification: G01, G21, G28