Which banks are more risky? The impact of business models on bank stability

• We analyze the impact of business models on stability in the EU banking sector.
• We include unlisted banks which represent the majority of EU banks.
• We show that banks will be more stable and profitable if they diversify into noninterest income.
• Benefits are particularly large for savings and cooperative banks, while investment banks become significantly more risky if they increase their non-interest income share.
• This implies that it is important to distinguish banks according to their business model when analyzing the impact of non-interest income on bank risk.

In this paper, we analyze the impact of business models on bank stability in 15 EU countries between 2002 and 2011. We represent banks’ business models by the share of non-interest income in total operating income and the share of non-deposit funding in total liabilities. In contrast to the literature, we include in our sample a large number of unlisted banks, which represent the majority of banks in the EU. We believe this to be important, since many unlisted banks typically have a more retail-oriented business model. We show that banks will be significantly more stable and profitable if they increase their share of non-interest income, indicating that substantial benefits are to be gained from income diversification. Such benefits are particularly large for savings and cooperative banks. Investment banks, in contrast, become significantly more risky. Diversifying into non-deposit funding has a different impact as well. While retail-oriented banks will be significantly less stable if they increase their share of non-deposit funding, investment banks will be significantly more stable. These findings indicate that it is important to enlarge the sample of banks and to include different types of banks with different business models in order to arrive at general conclusions about the effect of non-interest income and non-deposit funding on bank stability.