What drives investment bank performance? The role of risk, liquidity and fees prior to and during the crisis

This paper examines factors that affect the performance of investment banks in the G7 and Switzerland. In particular, we focus on the role of risk, liquidity and investment banking fees. Panel analysis shows that those variables significantly impact upon performance as derived from Stochastic Frontier Analysis (SFA). Given our sample also comprises the financial crisis, we further test for regime switches using dynamic panel threshold analysis. Results show different underlying regimes, in particular over the financial crisis. In addition, a strong positive effect of Z-Score on performance for banks in the regime of low default risk is reported, while fee-income ratio has also a positive impact for banks with low level of fees. On the other hand, liquidity exerts a negative impact. Notably, there is a clear trend of mobility of banks across the two identified threshold regimes with regard to risk a year before the financial crisis. Our results provide evidence that recent regulation reforms regarding capital adequacy and liquidity requirements are on the right track and could enhance performance.