Is bank income diversification beneficial Evidence from an emerging economy

2024-04-01 来源：榕意旅游网

Int.Fin.Markets,Inst.andMoney31(2014)97–126

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JournalofInternationalFinancialMarkets,Institutions&Money

journalhomepage:www.elsevier.com/locate/intfin

Isbankincomediversiﬁcationbeneﬁcial?Evidencefromanemergingeconomy

CélineMeslier,RuthTacneng∗,AmineTarazi

UniversitédeLimoges,LAPE,5rueFélixEboué,BP3127,87031LimogesCedex,France

article

info

abstract

Articlehistory:

Received11June2013Accepted23March2014

Availableonline31March2014

JELclassiﬁcation:G21G28

Keywords:

Emergingeconomies

BankrevenuediversiﬁcationBankriskandproﬁtability

Thispaperexaminestheimpactofbankrevenuediversiﬁcationontheperformanceofbanksinanemergingeconomy.Usingauniquedatasetwithdetailedinformationonnon-interestincome,ourﬁndingsshowthat,converselytostudiesonWesterneconomies,ashifttowardnon-interestactivitiesincreasesbankproﬁtsandrisk-adjustedproﬁtsparticularlywhenbanksaremoreinvolvedintradingingovernmentsecurities.Ourresultsalsoindicatethatforeignbanksbeneﬁtmorefromsuchashiftthantheirdomesticcounterparts.Moreover,weaccountfortheinstitutionalandregu-latoryenvironmentadvocatingloanstoSMEsandﬁndthathigherinvolvementinnon-interestactivitiesisonlybeneﬁcialforbankswithlowexposurestoSMEs.Ourﬁndingshaveimportantpolicyimplicationsintermsofachievingoptimaldiversiﬁcationandlowerriskexposure,whichmightconﬂictwithpoliciesaimingtopromoteSMElending.

1.Introduction

Overthelastthreedecades,theﬁnancialindustryindevelopedaswellasindevelopingcountrieshasexperiencedmajorchanges.Deregulationandincreasedcompetitionhasledbankstoexpandtheiractivitiesandtodevelopnewlinesofbusinessesbesidetheirtraditionalinterestactivities.Bankshave

∗Correspondingauthor.Tel.:+33685186453;fax:+33555149214.

E-mailaddresses:celine.meslier@unilim.fr(C.Meslier),ruth.tacneng@unilim.fr,ruth.tacneng@gmail.com(R.Tacneng),amine.tarazi@unilim.fr(A.Tarazi).

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

diversiﬁedtheirincomesourcesbyperformingnewactivities,suchasunderwritingandtradingsecu-rities,brokerageandinvestmentbankingandotheractivities,whichgeneratenon-interestincome.Theimplicationsofsuchchangesonbankperformance,i.e.proﬁtabilityandrisk,havebeenbroadlyaddressedfordevelopedcountries(U.S.andEurope)butnoconsensushasbeenreachedatthisstage.Moststudiesﬁndthatnon-interestactivitiesareoftenassociatedwithproﬁtabilitygainsbutalsohigherriskbecauseoftheirunstablenature(Stiroh,2004a,2004b,2006;StirohandRumble,2006;Lepetitetal.,2008a).Veryfewpapersfocusonemergingcountries(SanyaandWolfe,2011;Pennathuretal.,2012;Nguyenetal.,2012)andﬁndsomehowdifferentresults.Theobjectiveofthisstudyistocontributetothescarceliteraturededicatedtotheimpactofdiversiﬁcationonbankproﬁtabilityandriskinthecaseofemerginganddevelopingcountries.Suchcountrieshavelessmatureﬁnancialsys-temsanddifferentbankingmarketstructuresandinstitutionalandregulatorybackgrounds,whichcouldelicitdifferentimpactonbankperformanceofcreatingnewbusinesslines.

Inordertoassessthebankdiversiﬁcation/proﬁtabilityandrisknexusinemergingeconomies,wefocusonthecaseofthePhilippines.Focusingonasinglecountryenablesustoanalyzetheeffectsofdiversiﬁcationwithinauniformenvironment.OurpapercomplementstheempiricalinvestigationonIndianbanksbyPennathuretal.(2012)andextendsthecross-countrystudyofSanyaandWolfe(2011)usingadetailedbreakdownofnon-interestincomeofPhilippinebanks.Speciﬁcally,ourdataallowustodistinguishwithineachbroadnon-interestincomeaccount(fee-basedincome,tradingincomeandotherincome),activitiesprovidingtraditionalsourcesofnon-interestincome(bankcommissionsandserviceschargescollectedsuchasdepositorsservicesandﬁduciaryservices)fromactivitiesprovidingnontraditionalsourcesofnon-interestincome(feesandcommissionsconnectedwithinvestmentbankingactivitiesandtradinggain/lossondifferenttypesofsecurities).AspointedoutbyDeYoungandRice(2004),commercialbanksearntheirnon-interestincomefrombothtraditionalandnontraditionalbankingactivities.Wethusconsiderthisdistinctioninthisstudytobetterunderstandhowbanksgeneratetheirnon-interestincome,whichhasnotbeentreatedinexistingempiricalpapersfocusingonlessdevelopedeconomies.Wealsotakeintoaccountbanks’ownershiptypesinassessingbankproﬁtabilityandriskasthePhilippinebankingsystemhasexperiencedforeignbankentryaftertheﬁnancialliberalizationintheearly90sandisalsocharacterizedbythepresenceofsomestate-ownedbanks.Furthermore,weconsideraspeciﬁcregulationonPhilippinebanks,whichisalsoimplementedinseveralemergingeconomies.Philippinebanksarerequiredtosetasideatleast6%and2%oftheirloanportfoliotosmallandmediumenterprises,respectively.Otherwaystocomply,however,arepresent,whichincludethepurchaseofgovernmentnotes,securitiesandnegotiableinstrumentsofferedbytheSmallBusinessGuaranteeandFinanceCorporation(SBGFC).1Thesemaybethebestalternatives,especiallyforbanksthathaveunderdevelopedlendingtechnologiesinﬁnancingsmallbusinesses.Byimposingconstraintsonbanklendingbehavior,suchregulationsmayinﬂuencehowbanksefﬁcientlyallocatetheirscarceﬁnancialresources.Toourknowledge,thisistheﬁrststudyofbankdiversiﬁcationinanemergingeconomythatlooksintothisregulatoryaspect.2Thisquestionisofparticularinterestforemergingcountrieswherebanksplayacrucialroleintheﬁnancingofsmallandmediumenterprises(SMEs).InthePhilippines,micro,smallandmediumenterprisesaccountfor99%ofthetotalnumberofﬁrmsandcontributeto60%ofthetotalemploymentinthecountry.AninclusiveﬁnancialsystemisthereforevitaltofosterSMEdevelopment,whichboostseconomicgrowth.However,despitethemandatedsystemoflendingtoSMEs,accesstoﬁnanceremainstobeoneofthekeyconstraintsindoingbusinessinthePhilippines(WorldBank,2013).OurstudydoesnotaimtoprovideadirectassessmentoftheeffectofsuchSMEﬁnancingregulationonbankdiversiﬁcationbehaviorasdataonindividualbankloanportfoliodisaggregatedaccordingtothesizeofborrowingﬁrmsarenotavailable.Nevertheless,itprovidesinsightsontheimpactofmandatedcreditprogramstoSMEsonthebeneﬁtsordrawbacksofanincreaseinbankincomediversiﬁcationintermsofproﬁtabilityandrisk.Assuchregulationsencouragingbankstolendtoprioritysectors,includingSMEs,areimplementedinsome

RepublicActNo.6977,Section13.MandatoryAllocationofCreditResourcesofSmallandMediumEnterprises.

SanyaandWolfe(2011)ﬁndthatahigherbankingfreedomandbetterinvestorprotectionareassociatedwithhigherproﬁtability.However,theydonotexplicitlyexploretheeffectofsuchregulationsontheriskimplicationsofincreasedbankdiversiﬁcation.

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emergingcountrieslikeAfghanistan,India,thePhilippinesandPakistanourresultscouldalsoprovideusefulinsightsforotheremergingcountries.

Weconductourempiricalinvestigationoverthe1999–2005periodusingasampleof39universalandcommercialbanksinthePhilippineswithaverydetailedbreakdownofannualdataonincomestructureprovidedbytheCentralBankofthePhilippines.Thisallowsustodeeplyanalyzebankdiver-siﬁcationbehaviorbyexaminingtheeffectonproﬁtabilityandrisknotonlyofthemaincomponentsofnon-interestincome(fee-based,tradingandothernon-interestincome)butalsobyconsideringadetailedcategorizationofsuchcomponents.Estimationsarealsoconductedaccordingtobankowner-shipproﬁlesthatmaycausedivergenceinthediversiﬁcation–proﬁt/riskrelation.Inextension,wealsoexaminetheeffectofincomediversiﬁcationforaspeciﬁccategoryofbanksinthePhilippines,univer-salbanks,whoseadditionalfunctionsincludeengagementintheunderwritingofsecuritiesofothercorporations.3

Ourresultsindicatethatincomediversiﬁcationandashifttowardnon-interestincomehasapositiveinﬂuenceontheproﬁtabilityandrisk-adjustedproﬁtabilityofPhilippinebanks.ThisresultisconsistentwithSanyaandWolfe(2011)andPennathuretal.(2012),whoﬁndrevenuediversiﬁcationtobebeneﬁcialtobanksinemergingeconomies.Theimpact,however,isstrongerforforeignbanksthandomesticbanks.Moreover,weﬁndthatthegainsfromincomediversiﬁcationaremainlyderivedfromanincreaseintheinvolvementinnontraditional,non-interestgeneratingactivitiesofbanks,suchastradingsecurities.Weattributeourresults,whichareincontrastwiththeﬁndingsofseveralU.S.bankingstudiestodifferencesintermsofincomestructure.Tradingincomecomprisesalmosthalfofnon-interestincomecomparedwithlessthan10%inU.S.banks.Standardportfoliotheorypredictsthat,ashifttowardtradingactivities,whicharetheleastcorrelatedwithtraditionalintermediationactivities,wouldleadtolargerbeneﬁtsfromdiversiﬁcation.IncontrastwithwhatisobservedintheU.S.,wedonotﬁndevidencethattradingincome’svolatilitycancelsoutitspositiveimpactonproﬁtability.Overall,theseresultsshowtheimportanceofevaluatingtheeffectsofincomestructureonriskandreturndifferentlyforemerginganddevelopedeconomies.Asemergingeconomiesaresubjecttodifferentlegalenvironmentsandweakqualityofinstitutions,ﬁnancialmarketsintheseeconomiesmayfunctiondifferentlyandthus,generalizingfromstudiesfocusingonadvancedeconomieswouldbeoflimiteduse.

OurﬁndingsalsoshowthatbanksthatarelendinglesstoSMEsarethebeneﬁciariesofincreasedproﬁtsfromashifttowardnon-interestactivities,implyingpossiblehighswitchingcostsfromlendingtonon-lendingactivitiesforbanksthatspecializeinrelationshiplending.Banks,whichareinabetterpositiontodiversifytheirincomeportfolioawayfrominterest-generatingactivities,aremorelikelytoalternativelycomplywiththemandatedcreditprogram(i.e.throughthepurchaseofSBGCFlia-bilityinstruments).Forthesebanks,reallocatingresourcesawayfromproﬁtablenon-interestincomegeneratingactivitiestothelessfamiliarSMEmarketmaybeverycostly,whichmaydiscouragecom-pliancebydirectlylendingtoSMEs.Finally,wealsoinvestigateasubsampleofuniversalbanksandﬁndthathigherinvolvementininvestmenthouseactivitiesisassociatedwithhigherrisk.

Theremainderofthepaperisorganizedasfollows.Section2reviewstheexistingliteratureandSection3discussesthedataandvariablesusedinourstudyandpresentsrecenttrendsintheincomestructureofthePhilippinebankingindustry.Section4describesthehypothesestested,themethodandtheeconometricspeciﬁcations.Section5providestheresultsofourestimationswhileSection6goesdeeperbyinvestigatingfurtherissues.Section7presentstherobustnesschecksandSection8summarizestheﬁndingsandconcludesthepaper.

2.Reviewofexistingliterature

DeregulatinginitiativeswhichtookplacebothinEuropeandintheU.S.duringthelastdecadesresultedinanexpansionofthescopeofbankactivitiesandashiftfromtraditionaltonontraditionalsourcesofincome.Hence,alargebodyofresearchfocusesontheimpactofdiversiﬁcationforbanksin

RepublicAct8791;PresidentialDecreeNo.129.

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developedcountries.InvestigatingtheU.S.bankingindustry,moststudiesﬁndthatincreasedinvolve-mentinnon-interestactivitiesincreasesrisk.DeYoungandRoland(2001),Stiroh(2004a,2004b),Stiroh(2006)andStirohandRumble(2006)ﬁndthatahighershareofnon-interestincomepositivelyaffectsthevolatilityofbankreturns.Inarecentwork,DeYoungandTorna(2013)analyzethecon-tributionofincomediversiﬁcationonbankfailureduringtheﬁnancialcrisis.Theauthorsﬁndthattheshifttowardnontraditionalbankingactivitieshassigniﬁcantimpactontheprobabilityofbankfailureduringthecrisisdependentonthebank’sﬁnancialconditions.Whilehigherinvolvementinnontraditionalactivities,suchasinvestmentbankingorproprietarytrading,reducesthechanceforahealthybanktofail;engagementintheseactivitiesincreasestheprobabilityoffailureforﬁnanciallydistressedbanks.

ConsistentwithU.S.studies,Europeanbanks’shifttonon-interestactivitiesalsoincreasesbankrisk.Lepetitetal.(2008a)showthatbanksthataremorereliantonnon-interestactivitiesexhibithigherdefaultriskthanbankswhichmainlysupplyloans.Thispositivelinkmainlyholdsforsmallbanksandisessentiallydrivenbycommissionandfeeactivities.Ahighershareoftradingactivi-tiesisnotassociatedintheirstudywithhigherriskandforsmallbanksitimplies,insomecases,lowerassetanddefaultrisks.Merciecaetal.(2007)ﬁndthatsmallEuropeanbanksdonotbeneﬁtfromdiversiﬁcation.Highernon-interestincomesharesareassociatedwithlowerproﬁtabilityandincreasedriskimplyinglowerrisk-adjustedproﬁts.Further,theyﬁndtradingactivitiestobebothriskyandunproﬁtable.Conversely,analyzingItalianbanks,Chiorazzoetal.(2008)ﬁndthatincomediversiﬁcationimprovestherisk/returntrade-offandsuchdiversiﬁcationgainsarestrongerforlargebanks.Investigatingtheeffectofdiversiﬁcationonsystemicrisk,DeJonghe(2010)showsthattheshifttowardnontraditionalbankingactivitiesinEuropeincreasesbanks’tailbetasandthus,reducesbankingsystemstability.

Whilealargenumberofstudiesanalyzetheeffectofincomediversiﬁcationonbankperfor-manceinthecaseofdevelopedcountries,relativelyfewpapersaddressthisissueonbanksindevelopingcountries.Implicationsofthesepreviousstudies,however,maynotbeapplicabletoemerg-ing/developingcountries.Indeed,differencesininstitutionalandregulatorybackgroundsandbankingmarketcharacteristicsinemerging/lessdevelopedcountriesanddevelopedcountriesmaywarrantdifferenteffectsofchangesinbankincomestructureonbankperformance.Animportantissueforemerginganddevelopingcountriesistheroleofcorporateownershipandgovernanceinaffectingbankbehavior.AsreportedbyDeNicoloandLoukoianova(2007),twomaintrendsinbankowner-shipstructureinemergingcountriescanbehighlightedoverthe1993–2004period.Whileforeignownershipsubstantiallyincreased,state-ownershipremainedstableandstilltendstoincreaseinsomegroupofcountries.Severalpapershaveinvestigatedtheeffectofahigherforeignpresenceonbankingcompetition,efﬁciencyandcreditavailabilityandﬁndcontrastingresults.4Pennathuretal.(2012)investigatetheimpactofownershipstructureontheincomediversiﬁcation–riskrelationshipinthecaseofIndianbanks.Theauthorshighlightthatpublicandprivatebankshavedifferentdiversiﬁ-cationstrategies,whichelicitdifferenteffectsonbankperformance.Foreignbanksarehighlyinvolvedinfee-basedactivitieswhilepublicsectorbankshavelowerfee-basedincomethanprivatedomes-ticbanks.Althoughtheyﬁndthatdiversiﬁcationintofee-basedandbrokerageactivitiesreducesthevolatilityofreturnsofpublicsectorbanks,higherinvolvementintheseactivitiesleadtohigherbankriskforbothprivatedomesticandforeignbanks.Higherfee-basedincome,however,isassociatedwithlowerdefaultriskforbothpublicsectorandprivatedomesticbanks.Theseresultsareconsis-tentwithSanyaandWolfe(2011)whohighlightthebeneﬁtsofincomediversiﬁcationforemergingcountries.Inacross-countrystudyconductedforasampleoflistedbanksfrom11emergingcountries,theauthorsﬁndthatdiversiﬁcationbetweeninterestandnon-interestactivitiesaswellaswithinbothtypesofactivitiesincreasesproﬁtabilityandreducesbankinsolvencyrisk.Nguyenetal.(2012)alsostressthebeneﬁtsfromdiversifyingrevenuesinemergingcountries.FocusingonthecaseofSouth

Foreignbankentryisgenerallyfoundtopositivelyimpactcompetitionand,insomecases,improvetheefﬁciencyofthelocalbankingsystem(Claessensetal.,2001;LensinkandHermes,2003).However,studiesregardingcreditavailabilityprovidemixedresults.Whileforsomeauthors,foreignbankentryreducescreditconstraints(Clarkeetal.,2006),otherssuchasDetragiacheetal.(2008)andGormley(2010)ﬁndthatforeignbankentrydoesnotnecessarilyimproveaccesstoﬁnanceforlocalﬁrms.

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Asiancountries,theauthorsexaminetheimpactofbankmarketpoweronthediversiﬁcation–bankriskrelationship.Theirresultsshowthatbankswithgreatermarketpowerreducetheirdefaultriskwhendiversifyingintonon-interestactivities.Conversely,Bergeretal.(2010)ﬁndevidenceofadiver-siﬁcationdiscount,whichisstrongerfordomesticbanksthanforforeignbanks,inChinesebanks.Theauthorsarguethatthisdiversiﬁcationdiscountcouldbeduetothelackofmanagerialexpertiseofthetopmanagementteamsandtothepresenceofineffectiveincentiveschemesforthemanagerstomaximizetheshareholders’wealth.MaudosandSolis(2009)highlighttheexistenceofanegativerelationshipbetweenbanks’interestmarginandnon-interestincomeforMexicanbanks.Theirﬁnd-ingsareconsistentwiththeresultsobtainedforEuropeanbanksbyLepetitetal.(2008b)indicatingpossiblecross-subsidizationofnon-interestactivitieswithtraditionalintermediationactivitieswherebanksuseloansasalossleader.

3.Dataandvariables,descriptivestatisticsandtrendsinthePhilippinebankingindustry

Thenatureandstructureofbanksinemergingeconomieshasbeenchanginginthepastdecadesbecauseofseveralfactors.HawkinsandMihaljek(2001)citesfourglobalforcesofchangeresponsibleforshapingtheemergingeconomies’bankingindustries–technologicalinnovation,deregulationofﬁnancialservices,changesincorporatebehaviorandthecrisesthatstruckAsiaandLatinAmericainthe90s.

Theintroductionofuniversalbankingin1980andtheﬁnancialliberalizationthatopeneduptheeconomytointernationalcompetitionhavepavedwaytothechangesinthewayPhilippinebanksdobusiness.GrowingcompetitionovertheperiodinthePhilippinebankingmarkethasprovidedincentivesforcommercialbankstodiversifytheiractivitiesandtoincreasetheshareofnon-interestactivities(Gochoco-Bautista,1999).Bankshavebeenprovidingabroaderarrayofﬁnancialservices,whichincludenotonlytheextensionofloansbutalsounderwritinganddistributingsecurities,saleofinvestments,onlinebankingandcommissionandfeeactivities.5Inaddition,severaldevelopmentsinthedomesticcapitalmarkethavebeeninitiatedinordertoenhanceoverallmarketconﬁdenceascapi-talmarketfundamentalsindicatethatthedepthoftheﬁnancialsystemandcapitalizationoftheequitymarketinthePhilippinesisshallowcomparedwithitsAsianneighbors.Governmentpapersdominateover90%ofthecapitalmarket,henceofferinglittleornoalternativeinstruments.6Improvementsinthecapitalmarketincludetheestablishmentofbasicﬁnancialinfrastructurefortheefﬁcienttradingandclearingandsettlementoftransactions.Theimplementationofaﬁxedincomeexchange(FIE)hascreatedtransparentandefﬁcienttradingofgovernmentsecuritiesandhaspromotedproperpricingofdebtsecurities,thuscreatingbetterliquidity.7TheBSPhasalsolaunchedaworld-classpaymentssystemcalledPhilPaSS,whichfacilitatestherealtimegrosssettlementoflargevalueinter-bankcashpayments,tradingofgovernmentsecuritiesandforeignexchange.Overall,thesereformsfacilitatetheinvolvementofbanksinnon-traditionalactivitiessuchassecuritiestrading.

InthePhilippines,banksareclassiﬁedinsixmaincategories8:universalbanks,commercialbanks,thriftandsavingsbanks,ruralbanks,cooperativebanksandIslamicbanks.In2005,universalandcommercialbanksalonecomprise89.29%,89.47%and90%9ofthetotalassets,depositliabilitiesandloansandinvestmentsoutstanding,respectivelyoftheentirePhilippinebankingsystem.Universalbankshavetheauthoritytoexercise,inadditiontothefunctionsauthorizedforacommercialbank,10

Overthepasttwentyyears,non-interestincomehasgrownover700%(200%morethanthegrowthrateininterestincome).InﬂationReportsSecondQuarter(2002,2005).BangkoSentralngPilipinas.7

FosteringEconomicRecoveryThroughCapitalMarketDevelopment,GovernoroftheCentralBankSpeechin2004.8

TheGeneralBankingLawof2000(RepublicActNo.8791).9

Author’scomputationsfromtheBankingStatisticspublishedintheBangkoSentralngPilipinaswebsite.10

ArticleII-OperationsofCommercialBanks(RepublicActNo.8791).Acommercialbankshallhave,inadditiontothegeneralpowersincidenttocorporations,allsuchpowersasmaybenecessarytocarryonthebusinessofcommercialbanking,suchasacceptingdraftsandissuinglettersofcredit;discountingandnegotiatingpormissorynotes,drafts,billsofexchange,andotherevidenceofdebt;acceptingorcreatingdemanddeposits;receivingothertypesofdepositsanddepositsubstitutes;buyingandsellingforeingexchangeandgoldorsilverbullion;acquiringmarketablebondsandotherdebtsecurities;andextendingcredit,subjecttosuchrulesastheMonetaryBoardmaypromulgate.

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thepowersofaninvestmenthouse.11Theseﬁguresshowthatuniversalandcommercialbanksaretheprimarylenderstobothhouseholdsandinstitutionsinthecountry.Theirbehaviorgenerallyshapesthatofthebankingsystemandimpactstheeconomy.

3.1.Datacollectionandsampleselection

Thesampleusedinthisstudyincludes39universalandcommercialbanksinthePhilippinesfrom1999to2005.Theamendment12ofthemanualofaccountsandtheCentralBank’sreportorialrequire-mentsforbanksimplementedin2006doesnotallowustohavethesameincomecategorizationsafter2006.Weconstructoursampleusingtwocriteria:(1)banksmusthaveatleastdataforthreeyearsand,(2)thegrossincomecomponentsmustbenon-negative.Theﬁrstcriterionissettoconﬁnethepanelregressionsonbankswithsufﬁcientnumberofobservations.Meanwhile,thesecondcriterionensuresthatthediversiﬁcationmeasures,particularlytheindicesandincomesharesareboundedfrom0to1.Wealsoapplyseveralmeasurestocheckthepresenceofoutliersandinﬂuentialobservations.13Wealsoexcludebanksthatweremergedand/orwereacquiredduringtheperiod.14Wehenceendupwithanunbalancedpanelconsistingof39banksand218observations.

Oursampleofbanksrepresents86.81%15ofthePhilippinebankingsystemand96.3%oftheuni-versalandcommercialbankingsystemintermsoftotalassets.16

Thewholesampleconsistsof23domesticand16foreignbanks,17and16listedand23non-listedentities.Intermsofassetsize,weidentify8largebanks(AverageAsset>140billionpesos),13medium-sized(30billionpesosBalancesheetandnetincomeinformationareobtainedfromtheDataCenteroftheBangkoSentralngPilipinasanditswebsiteonanannualbasis.18Ouruniquedatasetprovidesusadetailedbreakdownofoperatingincomeanditscomponents.Thisenablesustocarryoutanindepthstudyonnon-interestincome,itsmaincomponents–fee-based,tradingandothernon-interestincome,andtheirrespectivedisaggregation.Fee-basedincomeincludebankcommissionsfromopeninglettersofcredit,handling

FromtheOmnibusRulesandRegulationsforInvestmentHousesandUniversalbanksregisteredasunderwritersofsecu-rities,aninvestmenthouseisdeﬁnedasanyenterprisewhichprimarilyengages,whetherregularlyoronanisolatedbasis,inunderwritingsecuritiesofanotherpersonorenterprise,includingsecuritiesoftheGovernmentoritsinstrumentalities.12

CircularNo.512.AmendmentoftheManualofAccountsandBSPReportorialRequirementsforBanks.TheFinancialRepor-tingPackage(FRP)isdesignedtoaligntheManualofAccountsandtheBSPReportorialrequirementswiththeprovisionsofthePhilippineFinancialReportingStandards(PFRS)andPhilippineAccountingStandards(PAS).ThenewBSPreportorialrequirementsshallbecomeeffectivestartingwiththe31December2006month-end/quarter-endreports.13

Asidefromgraphicallylookingatboxplotsandscatterplotstoidentifyoutliers,weconﬁrmtheseoutliersbycomputingtheDFBETAandleveragemeasuresaftertheestimations.TheDFBETAmeasuresthedistancethataregressioncoefﬁcientwouldshiftwhenanobservationisincludedorexcludedfromtheregression,scaledbytheestimatedstandarderrorofthecoefﬁcient(Baum,2006).14

Weexcludebanksthatweremergedandacquiredduringtheperiodbecausetherearenotenoughobservationsforthesebankstoincludeinourstudy.15

Meanovertheperiodofthestudy.16

In1999,thereareatotalof46universalandcommercialbanks,andin2005,41universalandcommercialbanks.17

Banksareclassiﬁedasforeignif:(1)theyaresubsidiariesofforeignbanks,or(2)branchesofforeignbanks.ThisclassiﬁcationismainlydrawnfromtheMonetaryBoard’sauthorizedmodeofentry(Sec.2,RepublicActNO.7721)offoreignbankstooperateinthePhilippinebankingsystem.Sec.2.ModesofEntry–TheMonetaryBoardmayauthorizeforeignbankstooperateinthePhilippinebankingsystemthroughanyofthefollowingmodesofentry:(i)byacquiring,purchasingorowninguptosixtypercent(60%)ofthevotingstockofanexistingbank;(ii)byinvestinginuptosixtypercent(60%)ofthevotingstockofanewbankingsubsidiaryincorporatedunderthelawsofthePhilippines;or(iii)byestablishingbrancheswithfullbankingauthority:provided,thataforeignbankmayavailitselfofonlyone(1)domesticbankofnewbankingsubsidiary.(RepublicActNO.7721,AnActLiberalizingtheEntryandScopeofOperationsofForeignBanksinthePhilippinesandforotherpurposes).18

www.bsp.gov.ph.

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ofcollectionitemsandsaleofdemanddrafts;servicecharges/feesfromhandlingofloansandtransac-tions;andothercommissionsearnedfromservicesconnectedwiththeinvestmenthousefunctionsofthebanksuchasunderwriting.Tradingincomearethosegeneratedfromtradinggovernmentsecuri-ties,privateequity/debt;ﬁnancialfutures,forwardsandswaps;saleofinvestments;andfromforeignexchange.Thisdetaileddisaggregationofnon-interestincomeallowsustofurtherexaminewhetherfee-basedincomeandtradingincomearegeneratedmainlyfromthetraditionalorthenontraditionalactivitiesofthebank.DeYoungandRice(2004)citethatwhilenontraditionalfee-generatingactiv-itiesincludeinvestmentbanking,securitiesbrokerage,insuranceactivitiesandmerchantbanking,traditionalfee-generatingactivitiescomprisedepositaccountservices,lending,cashmanagementandtrustaccountservices.

Forthelistedbanksofoursample,dailymarketdataforstockpricesareobtainedfromDatastreamInternational.

3.2.Deﬁnitionofvariables

3.2.1.Diversiﬁcationmeasures

Inthisstudy,twosetsofdiversiﬁcationindicatorsarecomputedandalternativelyusedtoassesstheeffectoftheincreaseddiversiﬁcationofPhilippinebanksontheirproﬁtabilityandrisk.

Aﬁrstsetofindicatorsusedinthisstudyconsistsofratioswhichrepresenttheshareofnon-interestincomeintotaloperatingincome,aswellasthesharesofeachcomponentofnon-interestincomeintotaloperatingincome.ThevariableNIIisequaltothepercentageshareofnon-interestincomeintotaloperatingincome,wherenon-interestincome19isthesumoffee-basedincome,tradingincomeandothernon-interestincome.Weusethegrossvaluesbecausethereisnocategoricalexpenseattributedtotheseactivitiesaloneintheincomestatementprovidedinourdata.Inaddition,thereportednon-interestexpenseisindependentofthenon-interestincome.OurdeﬁnitionoftotaloperatingincomeisconsistentwiththestudiesofStiroh(2004b),StirohandRumble(2006)andChiorazzoetal.(2008).

Inequation,NIIiscomputedasfollows:

NII=Non-interestincome/totaloperatingincome

(1)

WealsodisaggregateNIIintothreecomponentsasdeﬁnedbytheCentralBank–FEE,20TRADandOther.Thesevariablesarecomputedasfollows21,22:

FEE=Fee-basedincome/totaloperatingincome

(2)(3)(4)

TRAD=Tradingincome/totaloperatingincome

Other=Otherincome/totaloperatingincome

Asecondsetofindicatorsusedinthispaper,FOCUSk,consistsofHerﬁndahlindices.AsinChiorazzoetal.(2008),StirohandRumble(2006)andSanyaandWolfe(2011),theindicesmeasurehowfocusedorspecializedabankisonitsincomegeneratingactivities.Wecomputethemasfollows:

LetXi,tbethenominalexposureofbankiattimettoactivityjwherej=1,...,n.xi,tdenotesthecorrespondingrelativeexposure,i.e.

jxi,t

󰀃nXi,t

Xj=1i,t

(5)

Thedeﬁnitionofthenon-interestincomeaccountsareshowninAppendixA.

Thedeﬁnitionofthedifferentcomponentsofnon-interestincomearedrawnfromtheBangkoSentralngPilipinas’glossaryofterms,whichcanbefoundintheBSPwebsite,www.bsp.gov.ph/banking/glossary.asp.21

Fee-basedincome=Bankcommissions+servicecharges/fees+otherfees/commissions.22

Tradingincome=Tradinggains/(losses)(fromgovernmentsecurities,privatedebt/equitysecurities,andﬁnancialfutures,options)+Foreignexchangeproﬁts/(losses)+Goldtradinggains/(losses)+Proﬁt/(loss)onsaleofredemptionofinvestments.

1920

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FOCUSki,t

n󰀄j=1

(xi,t)

(6)

wherek=1,...,4.

FOCUSkisanindexequalto1whentotalincomeisgeneratedfromonesource(specialized)and1/nwhenexposurestoeachincomecomponentareequal(well-diversiﬁed).Alowervalueoftheindexindicatesthatabankismorediversiﬁed.kdenotesthelevelofdisaggregationofoperatingincome(FOCUS1),orofnon-interestincome(FOCUS2)anditscomponents(FOCUS3andFOCUS4)usedtocomputetheindicator.Ourﬁrstindex,FOCUS1isbasedonthedisaggregationoftheoperatingincome–netinterestincomeandnon-interestincome.Thethreeotherindicesweuse,FOCUS2,FOCUS3andFOCUS4,23arebasedonthedisaggregationofnon-interestincome,fee-basedincomeandtradingincome,respectively.

3.2.2.Bankproﬁtabilityandperformancemeasures

Tomeasuretheproﬁtabilityofabank,weusethebankincomestatementreturnonaverageassets(ROA)andconstructarisk-adjustedproﬁtabilitymeasure,SHROA,followingChiorazzoetal.(2008).WedeﬁneitastheratioofROAforagivenyeartothestandarddeviationofROAovertheperiodofstudy,1999–2005.

ROAit=

NetIncomeAfterTaxit((Assetit+Assetit−1)/2)

(7)(8)

SHROAit=

ROAit󰀄ROAi

3.2.3.Bankriskmeasures

Forthe16listedbanksinoursample,wecomputeriskandinsolvencymeasuresusingmarketdataobtainedfromDataStreamInternational.Thereareatotalof16listedbanksinoursample;however,sufﬁcientdataareonlyavailablefor15banks.Wecomputerisk-takingmeasuressuchas(i)themarketmodelbeta(Beta)24coefﬁcientestimatedthroughaGARCHmodelmeasuringsystematicrisk,(ii)totalrisk(TotRisk),whichisthestandarddeviationofweeklyreturns25and(iii)speciﬁcrisk(RiskSpec),26whichisthestandarddeviationofthemarketmodelresidual.Wealsocomputeadefaultriskmeasureusingamarket-data-basedZ-score(MZ).27Thismeasurerepresentsthenumberofstandarddeviationsbelowthemeanbywhichproﬁtswouldhavetofalltodepleteequitycapital(Boydetal.,1993).

3.3.MaintrendsinportfoliostructureandincomestructureinthePhilippinebankingsystem

Tables1Aand2Ahighlightsigniﬁcantdifferencesinincomestructureaccordingtobanksize(large,mediumandsmall),banktype(universalandcommercialbanks)andownershiptype(foreignanddomestic).

FOCUS2=(shareofinterestincometototaloperatingincome)2+(shareoffee-basedincometototaloperatingincome)2+(shareoftradingincometototaloperatingincome)2+(shareofothernon-interestincometototaloperatingincome)2FOCUS3=(shareofinterestincometototaloperatingincome)2+(shareofbankcommissionstototaloperatingincome)2+(shareofservicechargestototaloperatingincome)2+(shareofothercommissions/feestototaloperatingincome)2+(shareoftrad-ingincometototaloperatingincome)2+(shareofothernoninterestincometototaloperatingincome)2FOCUS4=(shareofinterestincometototaloperatingincome)2+(shareoffee-basedincometototaloperatingincome)2+(shareoftradinggainfromgovernmentsecuritiestototaloperatingincome)2+(shareoftradinggainfromprivatedebt/equitytototaloperatingincome)2+(shareoftradinggainfromﬁnancialfuturestototaloperatingincome)2+(shareofforeignexchangeproﬁttototaloperatingincome)2+(shareofproﬁtfromsaleofredemptionofinvestmentstototaloperatingincome)2+(shareofothernon-interestincometototaloperatingincome)2.24

Weestimatethesingleindexmarketmodelovertheperiod[t−100,t]tocalculatethevalueofthebetaatdatet.25

Dailystockpricesareusedtocalculateweeklystockreturns.Thestandarddeviationofweeklystockreturnsatdatetiscomputedovertheperiod[t−100,t].26

Thesingleindexmarketmodeliscomputedforeachtradingdayovertheperiod[t-100,t].Weusethestandarddeviationofresidualstoestimatespeciﬁcriskatdatet.27¯+1)/󰀄whereR¯isthemeanoftheweeklyreturnsRtforagivenyearand␴isthestandarddeviationofweeklyMZ=(Rreturns.

Table1A

DescriptivestatisticsforPhilippineuniversalandcommercialbanksoverthe1999–2005period.

Wholesample

Largebanks

Largebanksexcludinggovernmentbanks

Medium-sizedbanks

Smallbanks

1999

2005

1999–20051999

2005

1999–20051999

2005

1999–20051999

2005

1999–20051999

2005

1999–2005Assets71.710287.920827225321127726653.410169.612.118.313.9LOANS50.448.9849.0252.5346.6249.5952.4446.2249.8155.2239.746.2245.5456.7950.96EQUITY13.111.1112.9411.689.3411.0912.39.3111.4912.7210.2411.8114.1512.6114.86Deposits57.8856.958.8868.9864.7964.768.4770.1970.0369.0467.7270.543.3245.2346.39NII34.1632.4935.9235.6531.4538.1635.5435.3543.5334.6436.153932.9930.4132.22FEE13.1613.5613.3712.7513.914.1414.3917.8517.4814.9411.8713.612.0114.5912.78BC4.073.74.013.6933.934.194.085.064.292.372.684.125.015.14SC7.687.938.077.819.748.968.7712.2610.889.99.4110.645.915.975.53OC1.41.931.291.251.171.251.441.511.530.760.080.281.983.632.12TRAD16.4814.2916.8215.7711.5115.4513.1810.9516.2414.6518.0919.4718.2712.9715.41GS5.456.796.83.213.916.933.475.898.764.8713.19.786.894.314.58PD2.430.62.142.871.851.820.941.551.674.70.062.160.660.392.27FF0.040.260.3900.520.600.080.570.030.470.590.070.030.16PI0.861.441.432.843.272.640.352.271.040.792.012.4300.110.2FP8.385.786.656.397.524.77.166.675.046.23.275.0210.647.68.03Other4.524.645.857.136.038.817.966.5510.165.046.196.052.712.844.09ROA

0.62

1.54

0.94

0.76

0.33

0.97

0.68

0.33

1.04

0.75

1.02

0.92

0.67

2.14

1.04

DomesticBanks

DomesticBanks(excludingForeignBanks

UniversalBanks

CommercialBanks

governmentbanks)

1999

2005

1999–20051999

2005

1999–20051999

2005

1999–20051999

2005

All

1999

2005

1999–2005Assets1041411199812711029.841.132.812719016910.737.226.9LOANS53.8143.6947.9553.8743.2247.8645.9357.3650.9355.6144.4248.6748.6341.5246.73EQUITY17.1612.4215.6317.7412.7716.177.789.038.1314.3311.2813.4127.9514.9120.07Deposits68.666.2465.4668.386867.1143.8742.1247.0869.9671.2571.3963.6363.3661.07NII33.0833.0536.0232.8734.3837.4135.5731.6235.7331.9536.8639.3835.6530.8434.62FEE11.4111.5911.5911.9412.4812.3415.4616.6716.5710.812.8912.6615.3711.911.89BC2.42.22.522.512.432.736.266.16.692.953.093.41.191.481.77SC7.867.88.178.228.318.677.458.147.896.869.058.4912.317.268.93OC1.151.590.891.211.740.941.732.461.990.990.750.771.873.161.19TRAD16.0515.7217.8315.116.0618.2917.0312.0215.0115.1517.0118.7414.9514.717.66GS5.559.768.975.8111.129.595.351.833.084.99.698.438.0812.7911.13PD4.290.652.333.710.392.330.280.511.834.70.732.91.2201.56FF00.40.3400.280.310.10.040.4900.320.3100.230.31PI1.562.192.150.641.771.6500.240.380.872.282.4501.040.55FP5.843.935.296.143.755.4311.318.298.86.344.116.075.653.114.46Other5.625.736.855.835.847.063.092.934.0766.968.285.334.255.32ROA

0.77

1.19

0.94

0.8

1.18

0.93

0.41

2.08

0.94

0.71

0.95

0.9

1.07

1.52

0.97

Variabledeﬁnitions(Allvariablesareexpressedinpercentageexceptfortotalassets,whichisexpressedinbillionpesos)Assets:totalassets;LOANS:ratioofnetloanstototalassets;EQUITY:ratioofequitytototalassets;Deposits:ratiooftotaldepositstototalassets;NII:ratioofnon-interestincometototalnetoperatingincome;FEE:ratiooffee-basedincometototalnetoperatingincome;BC:ratioofbankcommissionsandfeestototalnetoperatingincome;SC:ratioofservicechargestototalnetoperatingincome;OC:ratioofothercommissionsandfeestototalnetoperatingincome;TRAD:ratiooftradingincometototalnetoperatingincome;GS:ratioofincomefromtradinggovernmentsecuritiestototalnetoperatingincome;PD:ratioofincomefromtradingprivatedebt/equitytototalnetoperatingincome;FF:ratioofincomefromtradingﬁnancialfuturesandotherderivativestototalnetoperatingincome;PI:ratioofproﬁtfromsaleofinvestmentstototalnetoperatingincome;FP:ratioofforeignexchangeproﬁttototalnetoperatingincome;Other:ratioofothernon-interestincometototalnetoperatingincome;ROA:returnonaverageasset;ROE:returnonaverageequity.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126105106

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

Overthe1999–2005sampleperiod,theshareofnon-interestincomeintotaloperatingincomeis,onaverage,equalto35.92%.Mostofthenon-interestincomeisdrawnfromtradingactivities(45.30%)comparedtofee-basedactivities(38%).Tradingingovernmentsecuritiesandforeignexchangeproﬁtarethelargestsourceoftradingincome28(30.60%and51.50%),whileservicechargesdominatethefee-basedincomesources(61.40%).Wecanobservedifferentproﬁlesofdiversiﬁcationandnon-interestincomestructureaccordingtothesizeandownershipstructureofthebank.Largerbankspresentahigherlevelofnon-interestincomeintotaloperatingincome(38.16%forlargebanksand39%formedium-sizedbanks)thansmallbanks(32.22%).However,thedifferencebetweenlargeandmedium-sizedbanksbecomesmorepronouncedwhenweexcludestatebanks.Non-interestincomeismainlygeneratedfromtradingactivitiesacrossbanksofdifferentsizes,withtheexceptionoflargebankswhenstatebanksareexcluded.Foreignexchangeproﬁtandtradingofgovernmentsecuritiesarethetwomainsourcesoftradingincomeforalltypesofbanks.However,whereasforeignexchangeproﬁtrepresentsthemaincomponentforlargeandsmallbanks(38.50%and67.60%),thetradingincomeofmedium-sizedbankscomesessentiallyfromthetradingofgovernmentsecurities(43.10%).

Intermsofownership,weobservethatthedegreeofinvolvementinnon-interestactivitiesissim-ilarbetweendomesticbanksandforeignbanks.Forforeignbanks,fee-basedactivitiesrepresentthemainsourceofnon-interestincome(47.70%),followedbytradingactivities(40.80%).Forthesebanks,foreignexchangeproﬁtisthemainsourceofrevenueintradingactivities(74.70%).Onthecontrary,domesticbanksaremoreinvolvedintradingactivities(47.80%),ofwhichgovernmentsecuritiestrad-ingisthelargestcomponent(41.90%).Markeddifferencesarealsoobservedbetweenuniversalandcommercialbanks.Universalbankshavehighersharesofnon-interestincomecomparedtocommer-cialbanks(39.38%and34.62%).Inaddition,commercialbankshavehighersharesoffee-basedincomebutuniversalbankspresentahigherinvolvementintradingandothernon-interestactivities.

Philippinebanksexhibithigherlevelsofinvolvementinnon-interestactivitiesthanthosereportedinSanyaandWolfe(2011)fortheirsetofemergingcountriesandsimilarlevelsofinvolvementinnon-interestactivitiesindirectcomparisonwiththosereportedinU.S.andEuropeanstudies.Weobservedifferences,however,intermsofthestructureofnon-interestincome.WestresstherelativelyhighinvolvementintradingactivitiesforPhilippinebanks.In2000,Stiroh(2004b)reportsthatinthecaseofU.S.banks,anaveragebank’sfeesandotherincomemakesup27%ofnetoperatingincome,whileonly3.5%comefromtradingincome.InEurope,Lepetitetal.(2008a)showthatoverthe1996–2002period,averagecommissionincomecomprises23.16%ofnetoperatingincome,and9.7%fromtrad-ingincome.Indeedthedifferencesintheincomestructureofbanksacrossbankingmarketsmaycontributetohowashifttowardnon-interestincomemayimpactbankproﬁtsandrisk-adjustedproﬁts.

4.Theoreticalframework,hypothesesandmodels

Thestructuralchangesinthebankingindustryandtheproliferationofalternativeﬁnancingsourcesforﬁrmshaveenabledbankstoconsistentlylookoutforotherwaystoincreasetheirproﬁtsbesideslending.Fromatheoreticalpointofview,banksbeneﬁtfromeconomiesofscopewhentheydiversifytheirincome(KleinandSaidenberg,1997).Banksincreasetheirefﬁciencyandenhanceproﬁtabilityastheytendtoeliminateredundantoperationsandcapitalizeonobtainedclientinformationwhentheyprocessloanstofacilitateprovisionofotherﬁnancialservices.

Conventionalwisdomassertsthatrevenuediversiﬁcation,orashiftfrominteresttonon-interestincome,shouldreducetotalrisk.Activitiesthatgeneratenon-interestincomearethoughttobenega-tively,weaklyorimperfectlycorrelatedwiththosethatproduceinterestincome,therebystabilizingproﬁtsandimprovingtherisk-returntrade-off.Inaddition,ashifttowardnon-interestincomeisbelievedtoreducecyclicalvariationsofbankproﬁts,dependinglessonoverallbusinessconditions(Stiroh,2004b).

ThemeanofthedifferentcategoriesofTRAD(GS,PD,FF,PIandFP)donotnecessarilyadduptothatofTRADbecauseofthesecondcriterionusedtoselectoursample:thegrossincomecomponentsmustbenon-negative,whichensuresthatthefocusindicesareboundedfrom0to1.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

107

Whileitmayseemthatdiversiﬁcationislargelydesirableforabank,argumentsthatrefutetheabil-ityofincomediversiﬁcationtoreduceriskareofferedinseveralbankingstudies.Notably,DeYoungandRoland(2001)offersthreewaysbywhichnon-interestincomemayincreasebankearnings’volatil-ity.First,thepresenceofhighswitchingcostsforborrowersassociatedwithlendingrelationshipsmaysuggestthatbankstendtoeasilyloseclientsfromafee-basedone.Second,abanktendstoadditionallyinvestintechnologyandhumanresourcesasitmovestowardactivitiesthatgeneratenon-interestincome;hence,increasingoperatingleverageandthus,earningsvolatility.Third,somefee-basedactivitiesthatmaybecarriedoutwithlittleornoregulatorycapitalcouldbeassociatedwithahighdegreeofﬁnancialleverage,whichincreasesearningsvolatility.Financialinnovation,suchastheincreasedbankusageofderivativeinstrumentsandotherﬁnancialtransactionshasalsoprovidedvariousopportunitiestoleverageaportfolio.Newrisksarecompoundedontopofexistingrisks,potentiallyoffsettingorcancelingoutthebeneﬁtsfromdiversiﬁcation.Wethustestthefollowinghypothesis:

Hypothesis1.Ashifttowardnon-interestincomeenhancesbankproﬁtabilityandreducesrisk,henceimprovingbankrisk-adjustedproﬁts.

5.Model1

Yit=˛it+ˇ1FOCUS1it+ˇ2NIIit+ıZit+εit

(9)

whereYitiseitherameasureofproﬁtability,risk-adjustedproﬁtabilityorrisk;FOCUS1itisthemeasureofdiversiﬁcationbasedonthebreakdownoftotaloperatingincomeintwocomponents(interestandnon-interestincome)andNIIitistheshareofnon-interestincome.Zitisavectorofcontrolvariables.

ˇ1measurestheimpactofdiversiﬁcationandˇ2,thedirecteffectofashiftfrominterestactivitiestonon-interestactivities.Ifincomediversityleadstohigherproﬁtsandrisk-adjustedproﬁts,onewouldexpectˇ1tobenegative.

WefollowherethemethodologydevelopedbyStirohandRumble(2006)inordertoassesstheeffectsofdiversiﬁcationtowardnon-interestactivities.Theimpactofachangeinnon-interestincomeonproﬁtabilityandriskismeasuredusingtheﬁrstderivativeofourdependentvariableswithrespecttonon-interestincome:

󰀁

∂Yit∂NIIit

󰀂

󰀁

󰀃=ˇ1

∂FOCUS1it

∂NIIit

󰀂

󰀃+ˇ2

(10)

Theﬁrsttermontheright-handsideofEq.(10)measurestheeffectofachangeinthenon-interestincomesharethroughitseffectondiversiﬁcation.AsinStirohandRumble(2006),werefertothisastheindirecteffectofachangeinnon-interestincome.Asthiseffectdependsbothonthesignofˇ1󰀃andthemagnitudeofthenon-interestincomeshare,theindirecteffectiscalculatedaccordinglyfordifferentlevelsofnon-interestincome.Meanwhile,ˇ2󰀃capturesthedirecteffectofashiftfrominterestincometonon-interestincome.Usingaportfolio-styleinterpretation,ˇ1󰀃measuresthecovarianceeffect,whileˇ2󰀃measuresthevarianceeffect.

Theneteffect,whichisthesumofthedirectandindirecteffects,determineshowproﬁtabilityandriskvarywithanincreaseintheshareofnon-interestincome.

Thedependence,however,betweenˇ1󰀃andˇ2󰀃raiseseconometricissuessinceNIIandFOCUS1arecollinear.Althoughbothestimatesmaybeunbiased,theirvarianceandcovarianceareoverestimated(Chiorazzoetal.,2008).Waldtestsneedtobeconductedtocheckthejointstatisticalsigniﬁcanceofˇ1󰀃andˇ2󰀃inthevariousestimations.Moreover,wealsoestimatetheequationbyusingonlyNIItocheckforrobustness.

Severalempiricalresearchstudiesarguethatthepotentialbeneﬁts/disadvantagesfromdiversiﬁ-cationmaydivergebecauseofownershipdifferences.Althoughtheimportanceofsizeinthebankdiversiﬁcation–risk/proﬁtabilitynexushasbeenlargelydocumentedintheliterature,lookingintoownershipproﬁlesofbanksmaybemorerelevantinourstudybecausemostforeignbanks,whicharebranchesandsubsidiariesofforeignbankinggroups,areconsidered“small”whenwetakeintoaccounttheirtotalassetsinthecountry.Categorizingbanksaccordingtosize,thus,mightunder-scorethegainsfromdiversiﬁcationof“large”banks.Accordingtotheliterature,suchbanksareina

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C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

betterpositiontomanageoperatingleverageassociatedwithshiftstowardactivitiesgeneratingnon-interestincomebecauseofeconomiesofscaleandtheircapabilitytointensivelyinvestininformationtechnology(DeYoungandRoland,2001).

Bankstrategiesdifferbecauseofdifferencesincustomerpreferences,informationqualityandpro-ductionmethods,whichcouldbedrivenbydifferencesinbankownershipproﬁles.Thereisatendencyforforeign-ownedinstitutionsorforeignbankstobemoreorientedtowardtransactionslendingandprovideﬁnancialservicestolargecorporateclientsratherthantolendtosmallerﬁrms,morelikelycateredbydomesticbanks.Empiricalstudiesshowthatforeignbankstendtohavewholesaleori-entationandmayfavorablylendtolargecorporateafﬁliatesoftheircustomersintheirhomenation(DeYoungandNolle,1996;GrosseandGoldberg,1991).Inaddition,foreignbanksaremoreexposedtodevelopedcountrybankingmarkets,whichtendtobemorecompetitiveandusemoresophisticatedinformationandcommunicationtechnologies(Claessensetal.,2001).Theseadvantagescouldfavorforeignbanksinmanagingoperatingandﬁnancialleveragewhendiversifyingtowardnon-interestactivities.

Toassessthepossibledivergenceintheeffectofashifttowardnon-interestincomebyownership,wetestthefollowingextensiontoHypothesis1.

Hypothesis1a.Ashifttowardnon-interestincomewilldifferentlyimpactproﬁtabilityandriskofbankswithdifferentownership.

WeuseModel1totestHypothesis1aonasubsampleofforeignbanksanddomesticbanks.

Knowingthesourcesofnon-interestincomeisimportantinbetterunderstandingthemechanismsbywhichincomediversiﬁcationmayaffectabank’sproﬁtabilityandrisk.AccordingtoDeYoungandRice(2004),itisfundamentallymisunderstoodthatcommercialbanksearnnon-interestincomemainlyfromnontraditionalbankingactivities.Theydemonstratethatthelargestsourceofnon-interestincomeofbanksintheU.S.comesfrompaymentservices–oneofthemosttraditionalofallthebankingservices.Bankshavealwaystraditionallyearnednon-interestincomefromdepositaccountservices,lending,cashmanagementandtrustaccountservice.Nontraditionalbankingactivi-tiesincludeinvestmentbanking,securitiesbrokerage,insuranceandtradingactivities.Thegrowthoftraditionalbankingactivitiesthatgeneratenon-interestincomeisexpectedtobepositivelycorrelatedwiththegrowthofinterest-generatingactivitieslikelending29andnontraditionalbankingactivitiestobeweaklyornegativelycorrelatedwithinterest-generatingactivities.

WefollowStiroh’s(2004a)frameworkofthedecompositionofportfoliogrowthvolatilityasshowninEq.(11).Netoperatingrevenueiscomposedofnon-interestincomeandnetinterestincome.Non-interestincomeisafunctionofincomefromtraditional(TRADTL)andnontraditional(NONTRADTL)bankingactivities.

222󰀄d=˛2󰀄d+(1−˛)2󰀄d+2˛(1−˛)Cov(dlnNON,dlnNET)lnOPREVlnNONlnNON

(11)

whereNON=f(TRADTL;NONTRADTL)

Ashifttowardnon-interestincomegeneratedfromtraditionalbankingactivitiesmaynotimplydiversiﬁcationbeneﬁts(orareductionofdiversiﬁcationbeneﬁts)sincetheyaresubjecttothesameﬂuctuationsasinterest-generatingactivitiesandmayleadtoincreasedearningsvolatility.Thismaybethecasewhenbankscross-selltheirotherﬁnancialproductstoacorecustomerbase.Diversiﬁcationbeneﬁts,however,ishigherwhenabankshiftstowardnon-interestincomegeneratedfromnontra-ditionalbankingactivities.However,standardportfoliotheoryalsoimpliesthattheoverallvarianceofoperatingrevenuerisesasthevolatilitiesofthegrowthratesofincomefrombothtraditionalandnontraditionalbankingactivitiesincrease.

Wedisaggregatenon-interestincomeintofee-based,tradingandothernon-interestincome.AsshowninTables1Aand1B,inthecaseofbanksinthePhilippines,wemay,however,associatefee-basedincomeandothernon-interestincomeasnon-interestincomegeneratedfromtraditionalbankingactivities.Fee-basedincomeareprimarilygeneratedfrombankcommissionscollectedfor

Wedonotdiscountthepossibilitythatthegrowthoftraditionalbankingactivitiesmaybeduetotheuseofnew,non-traditionalmethods,suchasadvancesininformationtechnology.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

109

Table1B

Non-interestincomecomponentsforPhilippineuniversalandcommercialbanksoverthe1999–2005period(in%).

Wholesample

Fee-basedactivitiesBankcommissionsServiceschargesOthercommissionsTradingactivities

GovernmentsecuritiesPrivatedebt/equityFinancialfutures

ProﬁtfromsaleofinvForeignexchangeproﬁtOther

Domesticbanks32.7021.1069.309.6047.8041.908.202.4011.8035.7019.50

Foreignbanks47.7042.2047.2010.6040.8013.907.902.800.7074.7011.50

Largebanks35.7023.5064.501241.3031.2094.9016.4038.5023

Medium-sizedbanks36.5019.8078.301.9047.2043.106.20410.9035.8016.30

Smallbanks40.8038.5046.1015.404621.4090.601.4067.6013.20

Universalbanks33.4024.1069.506.404636.909.902.5012.703820.60

Commercialbanks40.603157.1011.9044.9027.607.202.604.8057.8014.50

3828.6061.401045.3030.608.102.507.3051.5016.70

Variablesdeﬁnitions:Fee-basedactivities:ratiooffee-basedincometonon-interestincome;Bankcommission:ratioofbankcommissionsandfeestofee-basedincome;Servicecharges:ratioofservicechargestofee-basedincome;Othercommissions:ratioofothercommissionsandfeestofee-basedincome;Tradingactivities:ratiooftradingincometonon-interestincome;Governmentsecurities:ratioofincomefromtradinggovernmentsecuritiestotradingincome;Privatedebt/equity:ratioofincomefromtradingprivatedebt/equitytotradingincome;Financialfutures:ratioofincomefromtradingﬁnancialfuturesandotherderivativestotradingincome;Proﬁtfromsaleofinv:ratioofproﬁtfromsaleofinvestmentstotradingincome;Other:ratioofothernon-interestactivitiestonon-interestincome.

servicesasinopeningoflettersofcreditandsaleofdemanddrafts,andservicechargescollectedforhandlingloans.Othercommissionsandfees,whicharecollectedforservicesinconnectionwiththeinvestmenthousefunctionsofthebank,however,arelowtocausesigniﬁcantvariationsinthebank’srevenue.WehighlightthisasoneofthemaindifferencesbetweenbanksinemergingeconomiesanddevelopedeconomiessuchastheU.S.(DeYoungandRice,2004).Moreover,weassociatetrad-ingincometobenon-interestincomegeneratedfromnontraditionalbankingactivities.Weconﬁrmtheseassumptionsbyperformingpairwisecorrelationsofthegrowthratesofoperatingincome,itscomponents(interestincomeandnon-interestincome)andthenon-interestincomecomponents(fee-basedincome,tradingincome).Thegrowthrateoffee-basedincomeispositivelyandsigniﬁcantlycorrelatedwiththegrowthrateofnetinterestincome(0.1568,5%levelofsigniﬁcance)whiletradingincomeisweaklyandnegativelycorrelatedwithnetinterestincomegrowth(−0.0538).Similarly,wealsoﬁndthatthegrowthofinterestincomefromloansispositivelyandsigniﬁcantlycorrelatedwithfee-basedincome(0.1120,10%levelofsigniﬁcance),suggestingthatmostbanksmayseizecross-sellingopportunities,whichmaylessenbeneﬁtsderivedfromdiversiﬁcation.Wetestthefollowinghypothesis,

Hypothesis2.Ashifttowardnon-interestincomefromnontraditionalbankingactivitieswillgener-ategreaterdiversiﬁcationbeneﬁtsthanashifttowardnon-interestincomefromtraditionalbankingactivities.

Thishypothesiswillbetestedbyusingathree-levelbreakdownofnon-interestincome–fee-basedincome,tradingincomeandothernon-interestincome(Model2a).

Model2a

Yit=␣it+␤1FOCUS2it+␤2FEEit+␤3TRADit+␤4Otherit+Zit+␧it

(12)

whereYitiseitherameasureofproﬁtability,risk-adjustedproﬁtabilityorrisk;FOCUS2itisthemeasureofdiversiﬁcationbasedonthebreakdownofnon-interestincomeinthreecomponents(fee-based,tradingandotherincome);FEEit,TRADitandOtheritarethesharesoffee-basedincome,tradingincomeandothernon-interestincome,respectively,intotaloperatingincome.Zitisavectorofcontrolvariables.

Weusethefollowingcontrolvariables–ASSETS,GROWTH,EQUITY,LOANSandGDPinallourmodels.

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C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

ASSETisthenaturallogarithmofbankassetsadjustedtotheGDPdeﬂator.Thisvariable,followingChiorazzoetal.(2008),Behretal.(2007),StirohandRumble(2006),andStiroh(2004a,2004b)capturestheeffectsofbanksizeonreturnsandrisk.Larger-sizedbanksareabletoinvestinmoreadvancedtechnologiesandgenerally,havebetterriskmanagement.Theyarealsoabletoexpandintootherbusinesslines.Wethereforeexpectapositivesignfortherelationshipbetweensizeandproﬁtsandnegativebetweensizeandrisk.

GROWTHisthegrowthrateoftotalassets.AsinStiroh(2004b)andChiorazzoetal.(2008),weusethisvariableasaproxyforbankmanager’spreferenceforrisktaking.Bankswithlowerriskaversiongrowmorerapidlyandthus,havedifferentoperatingstrategies.Moreover,itmayalsobeinterpretedascontrolforgrowth-by-acquisition.

EQUITYistheleverageratiocomputedastheratiooftotalcapitaltototalassets.Banksthatholdalowerlevelofequityintheirasset-liabilityportfoliotendtoberiskier.Ahigherlevelofcapitalthentranslatestothebankmanager’sriskaversion.Thiscontrolvariableisalsousedbyseveralbankdiversiﬁcationstudies(Chiorazzoetal.,2008,Stiroh,2004b).

LOANSistheratiooftotalloanstototalassets.ConsistentwithChiorazzoetal.(2008),StirohandRumble(2006)andDeYoungandRoland(2001),thisvariablecapturestheperformanceofbank’slendingstrategiesrelativetoitsotherearningassets.

GDPisthelogarithmoftherealgrossdomesticproduct.Thisvariablecontrolsformacroeconomicﬂuctuationsandoverallperformanceoftheeconomy.Weexpectapositivesignasbankstendtoexpecthigherproﬁtswhentheeconomyisdoingwell.

Weruntwo-wayﬁxed-effectspanelregressionstoestimateourmodels.Inperformingtheseesti-mations,wecheckfortheappropriatenessofourestimationmethodusingtheHausmantesttocheckwhetheraﬁxedeffectsmodelismoreappropriatethanarandomeffectsmodel.Inaddition,weuseaHuber/Whiteestimatorofvariancethatisrobusttosometypesofmisspeciﬁcationsalongwiththeﬁxedeffectsmodel.

Sincethealternativedependentvariablesweuse,particularlyproﬁtability,showthetendencytopersistintime,30reﬂectingimpedimentstocompetition,informationalasymmetry,andchangeinbusinessstrategies,weconsiderthattheirpreviousvaluescouldpartiallydeterminetheircurrentvalues(Bergeretal.,2000).WethereforealsoestimateourequationsusingadynamicmodelusingthemethodologyproposedbyArellanoandBover(1995)andBlundellandBond(1998).Inthisapproach,thesystemofequationsissimultaneouslyestimatedinbothﬁrst-differencesandlevels.ThetwostepGMMestimatorisusedtoprovideamorerobustinferencefromtheresults.However,wealsousetheone-stepestimator.31Sinceweareconsideringasmallsample,thetwostepstandarderrorsarecomputedtoconformtoWindmeijer’s(2005)ﬁnite-samplecorrection.Wealsotakeintoaccountthepossibilitythattheexplanatoryvariablesmightnotbestrictlyexogenous,whichispresumablythecaseofthenon-interestincomevariables.FollowingMaudosandSolis(2009),toaddressthisendogeneityproblem,thelaggedlevelsandlaggeddifferencesoftheexplanatoryvariablesareusedasinstruments.Todeterminetheconsistencyoftheestimatorsandverifythevalidityoftheinstruments,weuseaSargantestofoveridentifyingrestrictions.Meanwhile,wealsocheckfortheappropriatenessofusingtheBlundelldynamicpaneldataestimationtechniqueusingthestatisticproposedbyArellanoandBond(1991)totesttheabsenceofsecond-orderserialcorrelationoftheﬁrstdifferenceresiduals.

6.Empiricalresults

Table2AreportstheresultsobtainedforModel1.Theregressionswithproﬁtabilityandrisk-adjustedproﬁtabilityshowpositivebeneﬁtsderivedfromanincreaseinincomediversityandashiftfrominteresttonon-interestincome,whichisconsistentwithHypothesis1.Thecoefﬁcientoftheshareofnon-interestincomeispositiveandhighlysigniﬁcant,whichisconsistentwiththeresultsobtainedbyChiorazzoetal.(2008),studyingItalianbanks.Thisﬁnding,however,isincontrastwith

Inthebankingliterature,fewstudiesconsiderproﬁtstobepersistent(Roland,1997;EichengreenandGibson,2001;Goddardetal.,2004).31

Resultsusingone-stepestimatorsarenotreportedbutareavailablefromtheauthorsonrequest.

Table2A

Incomediversiﬁcationandproﬁtability/riskforPhilippineuniversalandcommercialbanksoverthe1999–2005period(H1).

Fixedeffectspanelregression

Dynamicpaneldataestimation

ROA

SHROA

ROASHROA

Two-stepGMMS.E.

Two-steprobustS.E.

ROA

SHROASHROAROA

SHROAROA

SHROAROA(t-1)

0.345***0.315***0.371***0.316***0.345***0.315**0.371***0.316*(15.50)(4.79)(12.03)

(4.49)

(3.55)(2.20)(3.55)

(1.69)

FOCUS1−0.006−0.365−0.022***−4.630***−0.0217**−4.630**(−0.54)(−0.27)(−4.47)(−4.55)(−2.45)(−2.41)NII0.017**2.040***0.018***2.114***0.019***1.994***0.022***2.531***0.019**1.9940.022***2.531(2.62)(3.55)(3.03)(3.52)(4.27)

(2.97)(7.57)(4.55)(2.18)(1.43)(2.76)(1.58)ASSET0.026**2.814**0.026**2.847**−0.0071***1.094***−0.005**1.124***−0.0071.094−0.0051.124(2.30)(2.62)(2.33)(2.61)(−3.45)(2.87)(−2.56)(3.21)(−1.48)(1.34)(−1.07)(1.35)GROWTH−0.005***−0.098−0.005***−0.103−0.001−0.661*−0.002−0.654*−0.001−0.661−0.002−0.654(−3.28)(−0.94)(−3.32)(−1.05)(−0.53)(−1.68)(−0.92)(−1.65)(−0.16)(−0.57)(−0.30)(−0.52)EQUITY0.0345.612*0.0345.611*−0.031***−2.624−0.029***−2.999*−0.031−2.624−0.029−2.999(0.92)(1.74)(0.93)(1.76)(−3.22)(−1.40)(−2.93)(−1.77)(−1.33)(−0.45)(−1.25)(−0.50)LOANS0.025**1.0900.024**1.064−0.017***−0.099−0.021***−0.763−0.017*−0.099−0.021**−0.763(2.62)(1.48)(2.66)(1.52)(−8.34)(−0.16)(−10.45)(−1.08)(−1.93)(−0.06)(−2.57)(−0.39)GDP0.024**4.000***0.024**4.007***0.015***1.447***0.015***1.599***0.015*1.4470.015*1.599(2.65)(4.25)(2.66)(4.30)(3.53)(2.64)(3.75)(2.67)(1.65)(1.02)(1.71)(0.99)Constant

−0.449***−57.15***−0.459***−57.77***−0.002−17.67***−0.035−21.57***−0.002−17.67−0.035−21.57(−4.05)

(−6.00)

(−4.08)

(−6.01)

(−0.05)

(−3.47)

(−0.99)

(−4.29)

(−0.02)

(−1.37)

(−0.49)

(−1.59)R-square0.310.260.310.26OBS

218218218

218

187187187

187

187187187

187

Waldtest5.32***

6.63***

34.73***52.59***15.60***

26.17***

Sargantest

22.04

24.55

22.0128.04TestforautocorrM1:1storder0.040.000.030.000.040.010.030.01M2:2ndorder

0.11

0.97

0.13

0.79

0.11

0.97

0.14

0.79

t-statisticsarecorrectedforheteroskedasticityfollowingWhite’smethodologyfortheﬁxedeffectspanelregression.Variabledeﬁnitions:ROA:returnonaverageassets;SHROA:ratioofreturnonaverageassetstostandarddeviationofROA(annualdata);FOCUS1=focusindexbasedonatwopartoperatingincomebreakdown-non-interestincomeandinterestincome;NII:ratioofnon-interestincometototaloperatingincome;ASSET:logarithmoftotalassets;GROWTH:averageassetgrowth;EQUITY:ratioofequitytototalassets;LOANS:ratioofnetloanstototalassets;GDP:logarithmofthegrossdomesticproduct.*

Indicatessigniﬁcanceatthe10%level.

**Indicatessigniﬁcanceatthe5%level.

***

Indicatessigniﬁcanceatthe1%level.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126111112

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

Table2B

Estimatedimpactofachangeinshareofnon-interestincomeonproﬁtabilityandrisk-adjustedproﬁtability.

NII

ROA

SHROA

FixedeffectIndirect

Two-steprobustS.E.

Fixedeffects

Two-steprobustS.E.

Net

Indirect

Net

Indirect

Net

Indirect

Net7.87***(1.74)6.41***(1.28)4.82***(0.99)3.06***(1.12)0.49(1.89)

10th25th50th75th90th

0.007(0.014)0.006(0.01)0.004(0.007)0.001(0.003)−0.001(0.001)

0.024*(0.012)0.022**(0.009)0.02***(0.007)0.018***(0.006)0.016**0.007

0.028**(0.011)0.021**(0.008)0.0132**(0.005)0.005**(0.002)−0.007**(0.003)

0.046***(0.012)0.039***(0.010)0.032***(0.009)0.024***(0.008)0.012(0.010)

0.463(1.706)0.35(1.28)0.23(0.846)0.09(0.333)−0.059(0.216)

2.503(1.72)2.39*(1.331)2.270**(0.95)2.13***(0.619)1.981***(0.642)

5.88**(2.44)4.42**(1.83)2.83**(1.17)1.07***(0.44)−1.50**(0.62)

Indicatessigniﬁcanceatthe10%level.**

Indicatessigniﬁcanceatthe5%level.***

Indicatessigniﬁcanceatthe1%level.

severalU.S.bankingstudieslikeStiroh(2004a,2004b)andStirohandRumble(2006)andastudyofemergingeconomiesbySanyaandWolfe(2011),whichassociatesrisk-reductionbeneﬁtsfromincreasedshareofNIIbutnosigniﬁcanteffectintermsofrisk-adjustedproﬁts.

Asdiscussedintheprevioussection,ashifttowardnon-interestincomehastwoeffects:adirecteffectfromanincreasedrelianceonnon-interestincomeandanindirecteffectthroughchangesindiversiﬁcation.Table2Breportstheindirectandneteffectsofachangeintheshareofnon-interestincomeatvariouspercentilelevelsofnon-interestincomeshare.Regardlessofthelevelofnon-interestincome,ourresultssuggestthatanincreasedshareofnon-interestincomeoffersnosigniﬁcantindirecteffectsthroughdiversiﬁcationonbothproﬁtabilityandrisk-adjustedproﬁtability.Tomeasuretheeconomicsigniﬁcanceoftheseestimates,weconsidertheneteffectofachangeinnon-interestincomeshareasshowninTable2B.Evaluatingatthe50thpercentilevalueofNII,theresultspredictthataonestandarddeviationincreaseinnon-interestincomesharewillleadtoanincreaseintheROAandSHROAof0.02and2.27,respectively.Moreover,wehighlightthedecreasingneteffectsofNIIasthelevelofnon-interestincomeshareincreases.Thisresultconﬁrmsthediminishingmarginalbeneﬁtswhenbanksdiversifybeyondriskefﬁcientlevels(StirohandRumble,2006).

Chiorazzoetal.(2008)arguethattheinconsistencywiththeresultsoftheU.S.andEuropeanbank-ingstudiesisduetostructuralandregulatorydifferencesbetweentheEuropeanandU.S.markets,whichincludebanksize,longevityoffee-basedrelationshipsanddiffusionofcreditscoringmethods.Inourinterpretation,thecontrastintheresultsofmostU.S.bankingstudiesandourstudycomesfromtwomaindifferencesbetweentheincomestructureofthePhilippinebankingsystemandthatoftheU.S.:ﬁrst,thecorrelationbetweenthegrowthratesofinterestincomeandnon-interestincomeandsecond,thedistributionofthecomponentsofnon-interestincome.Stiroh(2004b)showstherel-ativelyhighcorrelationbetweeninterestincomeandnon-interestincomeinU.S.banksfrom1984to2001,implyinglessdiversiﬁcationbeneﬁtsasthebankingindustryshiftstowardnon-interestrev-enue.InthePhilippines,however,thecorrelationbetweenthegrowthratesofinterestincomeandnon-interestincomeisweak.Thediversiﬁcationbeneﬁtsfromincreasedeconomiesofscopecoupledwiththeweakcorrelationbetweennon-interestincomegrowthandinterestincomegrowthfuelsthepositiveimpactofashifttowardnon-interestincomeonrisk-adjustedproﬁtability.Wealsoobservesigniﬁcantdifferencesinthedistributionofnon-interestincomebetweenbanksinthePhilippinesandtheU.S.Stiroh(2004b)highlightsthatintheU.S.in2000,anaveragebank’sfeesandotherincomecomprise27%ofnetoperatingincomewhiletradingincome’sshareinthenetoperatingincomeisonly3.5%.WeshowthatinthecaseofthePhilippines(Table1A),in1999,tradingincome(16.5%of

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

113

Table3A

IncomediversiﬁcationandproﬁtabilityofPhilippineuniversalandcommercialbanksoverthe1999–2005period:impactofdifferencesinbankownershiptype(H1a).

Domesticbanks

Foreignbanks

ROA

SHROA

ROA

SHROA

ROA

SHROA

ROA

SHROA

FOCUS1NIIASSETGROWTHEQUITYLOANSGDPConstantR-squareOBS

Waldtest

−0.001(−0.14)0.006(1.43)0.012(1.08)0.005*(1.80)0.021(0.64)−0.003(−0.20)0.015**(2.11)−0.229**(−2.53)

−0.151(−0.10)1.585**(2.44)2.121(1.49)0.208(0.55)5.351(1.34)−0.676(−0.51)4.406***(4.05)−51.93***(−4.18)

0.006(1.41)0.0120(1.05)0.005*(1.82)0.021(0.65)−0.003(−0.22)0.015**(2.13)−0.232**(−2.34)

1.606**(2.30)2.139(1.47)0.208(0.55)5.355(1.35)−0.690(−0.56)4.409***(4.11)−52.23***(−4.07)

0.075(0.94)0.082*(1.87)0.045*(1.85)−0.006***(−5.46)0.107(0.98)0.025*(1.79)0.027(1.37)−0.732***(−3.13)

4.971(1.04)5.550**(2.37)3.736**(2.37)−0.097(−0.88)10.43(1.36)2.004*(1.99)2.565(1.41)−61.21***(−4.45)

0.051***(2.95)0.042*(1.85)−0.006***(−5.49)0.090(0.86)0.030**(2.47)0.028(1.56)−0.653***(−3.16)

3.511***(3.19)3.523**(2.23)−0.057(−0.52)9.316(1.23)2.279**(2.31)2.629(1.50)−55.95***(−4.59)0.3978

0.171401.04

0.241402.98*

0.17140

0.24140

0.55784.4**

0.40783.99**

0.5378

t-statisticsarecorrectedforheteroskedasticityfollowingWhite’smethodologyfortheﬁxedeffectspanelregression.Variabledeﬁnitions:ROA:returnonaverageassets;SHROA:ratioofreturnonaverageassetstostandarddeviationofROA(annualdata);FOCUS1:focusindexbasedonatwopartoperatingincomebreakdown-non-interestincomeandinterestincome;NII:ratioofnon-interestincometototaloperatingincome;ASSET:logarithmoftotalassets;GROWTH:averageassetgrowth;EQUITY:ratioofequitytototalassets;LOANS:ratioofnetloanstototalassets;GDP:logarithmofthegrossdomesticproduct.

******

Indicatessigniﬁcanceatthe10%level.Indicatessigniﬁcanceatthe5%level.Indicatessigniﬁcanceatthe1%level.

netoperatingincome)dominatesfee-basedincome(13.2%).Consistentwithoursample,U.S.banksexhibithighcorrelationbetweenthegrowthratesofnetinterestincomeandfee-basedincome,whileaweakcorrelationexistsbetweentradingincomegrowthandnetinterestincomegrowth.Thisisreasonableastradingincomeismoredependentonmarketﬂuctuationsthantraditionalbankingactivities,implyinggreaterdiversiﬁcationbeneﬁtsshouldabankdecidetoshiftitsinterestincometowardthisparticularcomponent(Stiroh,2004a).

Theimpactofanincreaseinincomediversiﬁcation,moreprecisely,ashifttowardnon-interestactivitiesonproﬁtabilityandrisk-adjustedproﬁtabilitydivergesaccordingtobankownershipproﬁle.Table3Ashowstheresultsonasubsampleofforeignversusdomesticbanks.Ourﬁndingsindicatethatincreasedincomediversitydoesnotaffectproﬁtsandrisk-adjustedproﬁtsbothwithindomesticandforeignbanks.Thedirecteffectofanincreaseintheshareofnon-interestincome,however,translatestohigherproﬁtsforforeignbanksandapositiveandsigniﬁcantimpactonrisk-adjustedproﬁtsinbothsubsamples.Togaugetheeconomicsigniﬁcanceoftheestimatedimpactofashifttowardnon-interestincome,wereporttheneteffectsaspresentedinTable3B.Theseestimatespredictthataonestandarddeviationincreaseinnon-interestincomesharewillleadtoanincreaseintherisk-adjustedproﬁtsof1.63and4.45,respectively,fordomesticbanksandforeignbanksathighersharesofNII(75thpercentile).Thismeansthatonlythedomesticandforeignbanksthatareheavilyinvolvedinnon-interestactivitiescanbeneﬁtfromashifttowardnon-interestgeneratingactivities.

Inthecaseofdomesticbanks,wehighlightthatthemarginalimpactofnon-interestincomeonrisk-adjustedproﬁts,thoughpositive,isdecreasingastheshareofnon-interestincomeincreases.Onthecontrary,forforeignbanks,afurthershiftgenerateslargerrisk-adjustedproﬁts.Thismaysuggestthatitpaysforforeignbankstospecializeinnon-interestactivities,consistentwiththestudiesofStein(2002),BergerandUdell(2006),whichhighlightthedisadvantageofforeign-ownedinstitutions

114

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Table3B

Estimatedimpactofanincreasedshareinnon-interestincome:impactofdifferencesinbankownershiptype.

NIIpercentiles

Domestic

ForeignROA

SHROA

Indirect

Net

Indirect

Net

Indirect

Net−0.138(3.78)0.993(2.797)2.484(1.693)4.452**(1.604)6.189**(2.868)

10th25th50th75th90th

***

0.198(2.063)0.149(1.543)0.095(0.988)0.041(0.426)−0.055(0.571)

1.784(2.218)1.734(1.728)1.68(1.230)1.626*(0.809)1.53*(0.826)

−0.086(0.091)−0.069(0.073)−0.046(0.049)−0.017(0.018)0.010(0.010)

−0.004(0.053)0.013(0.036)0.036*(0.017)0.065**(0.028)0.091(0.053)

−5.688(5.45)−4.558(4.367)−3.066(2.938)−1.099(1.053)0.639(0.612)

Indicatessigniﬁcanceatthe10%level.Indicatessigniﬁcanceatthe5%level.

incollectingsoftinformationthatiscrucialinlendingtosmalllocalﬁrmsandlackofknowledgeofthelocaldomesticmarket.Indeed,foreignbanksarefoundtohaveverylowsharesofsmallbusinessloansintheirassetportfolio.In2005,atleastaquarteroftheforeignbanksinthePhilippinesdidnotcomplywiththeMagnaCartaformicroandsmallenterprises,whichmandatesbankstoﬁnancesmallﬁrms(Khoretal.,2013).Inaddition,althoughtheﬁnancialliberalizationin1994allowedforeignbankstoestablishbranches,eachofthemwasrestrictedtosetupsixbranches–threeinlocationsoftheirchoice,andthreeinlocationsdesignatedbytheMonetaryBoard(Milo,2001).Hence,itisnotsurprisingthattheyhavethetendencytofavorlendingtolargecorporationsandafﬁliatesoftheirclientsintheirhomecountry(DeYoungandNolle,1996;GrosseandGoldberg,1991).

Wereportresultsoftheimpactofashifttowardthedifferentcomponentsofnon-interestincomeonproﬁtsandrisk-adjustedproﬁtsinTable4.Consistentwithoursecondhypothesis,ourﬁndingssuggestthepresenceofgreaterbeneﬁtsfromdiversiﬁcationifabankshiftsfromtraditionalinter-estgeneratingactivitiestowardnontraditionalbankingactivitiesthatgeneratenon-interestincome.Indeed,weobservepositiveandsigniﬁcantdirecteffectsofanincreaseintheshareoftradingincometooperatingincomeonrisk-adjustedproﬁts.Moreover,weﬁndanegativeeffectofashifttowardfee-basedincomeonrisk-adjustedproﬁts,whichisconsistentwithseveralU.S.bankingstudieslikeStirohandRumble(2006)andStiroh(2004b).Theseresultsmaybedrivenbythepositivecorrelationbetweenthegrowthratesofnetinterestincomeandfee-basedincome,implyingthatcross-sellingishighlylikelyinPhilippinebanksandthepresenceofablurringdemarcationlinebetweenincomefromlendingandfee-basedincome.Furthermore,itisreasonablethatashifttowardtradingincometranslatestogreaterbeneﬁtsfromincreaseddiversiﬁcationasitsgrowthshowsweakcorrelationwithtraditionalbankingactivities,respondingmoretodifferentshockssuchasmarketﬂuctuations.

Forourcontrolvariables,overall,weﬁndthatbanksize,ASSET,measuredbythenaturallogarithmofbankassetshasapositiveimpactonROAandSHROA,butofwhichtheimpactdecreasesasthelevelofnon-interestincomeincreases.Whenweexaminethesubsampleofdomesticbanksandforeignbanks,however,weobserveapositiverelationshipbetweenproﬁtsandanincreaseinbanksizebutonlyforforeignbanks.Thismaysuggestthatforeignbanksarebetterabletoexploitscaleeconomiesandhavemoreefﬁcientriskmanagementtechniques.ThecoefﬁcientsassociatedwithLOANSarepositiveandsigniﬁcantintermsofROA,butonlyforourﬁxedeffectspanelregressions.Wedonotﬁnd,however,anysigniﬁcantrelationbetweenanincreaseinlendingactivityandrisk-adjustedproﬁts.OurresultsareinlinewithDeYoungandRice(2004)butslightlydifferfromthoseofChiorazzoetal.(2008)whoﬁndapositiveimpactofincreasedloansonrisk-adjustedreturns.Theratioofequitytototalassetshasanambiguouseffectonproﬁtsandrisk-adjustedproﬁts.WeobserveanegativerelationshipbetweenROAandEQUITY,suggestingthatanincreaseinbankcapitalizationtranslatestolowerproﬁts.Ourﬁxedeffectsregressionresults,however,suggeststhatanincreaseinbankcapitalizationincreasesrisk-adjustedproﬁts.GROWTHmeanwhilehascontradictingeffectsonROA,notablyindomesticand

Table4

Productmixeswithinnon-interestactivitiesandproﬁtability/riskforPhilippineuniversalandcommercialbanksoverthe1999–2005period(H2,model2).

Fixedeffectspanelregression

Dynamicpaneldataestimation

ROA

SHROA

ROA

SHROA

TwostepGMMS.E.

TwosteprobustS.E.

TwostepGMMS.E.

TwosteprobustS.E.

ROA

SHROAROA

SHROAROASHROAROASHROAROA(t-1)0.260***0.130***0.260**0.1320.3***

0.188***

0.25**

0.188*(5.66)

(2.74)

(2.32)

(1.31)

(6.16)(3.28)

(1.99)

(1.70)

FOCUS2−0.004−0.337−0.014**−2.120***−0.014−2.123(−0.26)

(−0.19)

(−2.15)(−2.60)(−0.65)

(−1.07)FEE0.005−0.4410.008−0.260−0.023***

−2.599*

−0.023−2.599−.01***−2.157−0.012−2.157(0.35)

(−0.31)(0.63)(−0.26)(−4.11)(−1.82)(−0.99)

(−0.85)

(−3.64)(−1.53)(−0.72)(−0.76)TRAD0.0232.9***

.030***

3.161***

0.017***1.610***

0.0171.612.02***2.148***

0.02**

2.148**(1.67)

(2.80)

(2.90)

(4.80)

(4.71)

(3.03)

(1.10)

(1.02)

(9.37)

(5.47)

(2.39)

(2.03)Other−0.020−2.025−0.016−1.724−4.970−0.007−4.970***−0.007−0.0152−5.06***−0.015−5.058(−0.93)(−0.82)(−0.85)(−0.81)(−0.61)(−4.71)(−0.31)

(−1.34)(−1.21)

(−3.96)(−0.58)

(−1.35)ASSET0.02**

2.58**0.03**2.600**

−0.008***

1.550***

−0.0081.553**

−0.0041.113***

−0.0041.113(2.49)

(2.68)

(2.52)(2.68)

(−3.38)(4.14)(−1.57)(2.14)

(−1.49)

(4.06)

(−0.67)

(1.59)GROWTH−0.01***−0.186*−.01***

−0.188*0.0005−0.7***

0.0005−0.695−0.0023−1.05***−0.002−1.053(−3.77)

(−1.79)

(−3.78)(−1.85)

(0.30)

(−3.47)(0.09)

(−1.60)

(−1.35)(−4.28)(−0.37)

(−1.52)EQUITY0.0234.6360.0234.623−0.037***−4.157**

−0.037−4.157−.040***

−8.69***

−0.035−8.70***(0.68)(1.46)

(0.69)(1.48)

(−4.50)(−2.13)(−1.37)(−1.37)(−5.62)(−5.73)

(−1.30)(−2.66)LOANS0.028**

1.1400.030**

1.125−0.016***

−0.044−0.016*

−0.044−.020***

0.062−0.018*

0.062(2.42)(1.45)(2.44)(1.49)(−6.38)(−0.10)(−1.76)(−0.03)(−6.49)(0.15)(−1.78)(0.04)GDP0.029***

4.6***

.030***

4.561***

0.024***3.09***

0.024**3.09**

.02***2.976***

0.02*2.976**(3.09)

(4.49)(3.09)

(4.55)

(6.27)

(5.26)

(2.27)

(2.15)

(4.72)

(4.86)

(1.68)

(2.17)Constant−0.46***−58***

−0.500***−58.6***−0.046***−33.90***−0.046−33.90***−0.10***−29.2***−0.068−29***

(−4.42)

(−6.66)(−4.43)

(−6.76)

(−3.16)

(−7.39)

(−0.61)(−2.87)

(−5.99)

(−10.20)(−0.92)

(−3.43)R-square0.370.340.360.34OBS

212

181

181181181

181

Wald**test3.77**8.64***

180.15***197***12.7732.1***

Sargantest

0.9

0.9Testforautocorr:M1:1storder0.030.010.050.010.030.010.050.02M2:2ndorder0.17

0.79

0.21

0.69

0.16

0.80

0.21

0.80

Partialcoeff:

FeeBased0.004

***−0.531−0.027−3.170**−0.027−3.170Trading0.0222.886*

0.013**0.8940.0130.894Other

−0.020

−2.064

−0.009

−5.229

−0.009

−5.229

t-statisticsarecorrectedforheteroskedasticityfollowingWhite’smethodologyfortheﬁxedeffectspanelregression.Variabledeﬁnitions:ROA:returnonaverageassets;SHROA:ratioofreturnonaverageassetstostandarddeviationofROA(annualdata);FOCUS2:focusindexbasedonafour-partoperatingincomebreakdown-feebasedincome,tradingincomeandothernon-interestincome;FEE:ratiooffee-basedincometototaloperatingincome;TRAD:ratiooftradingincometototaloperatingincome;Other:ratioofothernon-interestincometototaloperatingincome;ASSET:logarithmoftotalassets;GROWTH:averageassetgrowth;EQUITY:ratioofequitytototalassets;LOANS:ratioofnetloanstototalassets;GDP:logarithmofthegrossdomesticproduct.

*Indicatessigniﬁcanceatthe10%level.**Indicatessigniﬁcanceatthe5%level.

***

Indicatessigniﬁcanceatthe1%level.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126115116

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

foreignbanks.Weﬁndthatasbanksgrowrapidly,proﬁtsalsosoarinthecaseofdomesticbanks,whileproﬁtsdeclineinthecaseofforeignbanks.Wedonotﬁnd,however,anysigniﬁcantimpactofachangeinassetgrowthonrisk-adjustedproﬁts.Wealsocontrolforthelevelofgrowthoftheeconomy,GDP,andoverall,ourresultsshowthatexpectedbankproﬁtsandrisk-adjustedproﬁtsbeneﬁtfromstrongereconomicgrowth.

7.Furtherinvestigation

7.1.SMElendingandincomediversiﬁcation

ThehistoryofPhilippinebankingrevealsadevelopmentalroleassignedtothebankingsystem.Severalmandatedcreditprogramsareimposedwiththeaimofallocatingcredittosectorsthatarecriticalfromasocialstandpoint.LendingtargetssetforprioritysectorsareimposedinseveralemergingeconomieslikeIndia,Afghanistan,thePhilippines,PakistanandSriLanka(CGAPFinancialAccess,2010).Fromatheoreticalpointofview,mandatedcreditprogramsareinefﬁcientwaystoallocatescarceﬁnancialresources,potentiallydistortingbankstrategies(MedallaandRavalo,1997).

OneofthemandatedcreditprogramsinthePhilippinesistheMagnaCartaforSmallandMediumEnterprises(SMEs).AsstipulatedintheRA6977,32alllendinginstitutions,suchasbanksaremandatedtosetasideatleastsixpercent(6%)andatleasttwopercent(2%)oftheirtotalloanportfoliotosmallandmediumenterprises,respectively.Thereare,however,alternativewaystocomplywiththisspeciﬁcregulation.BanksmaysubscribetothepreferredsharesoftheSmallBusinessGuaranteeandFinanceCorporation(SBGFC)orsubscribeorpurchaseliabilityinstrumentsasmaybeofferedbySBGFC.33

Ashighlightedintheliterature,smallbusinesslendingtendstorelymoreonrelationshiplendingwherebankshavetogathersoftinformation.Althoughrecentliteraturesuggestsseverallendingtech-nologiessuchascreditscoringandfactoringmaybeusedbybankstocatertoinformationallyopaquesmallﬁrms,largebanksinemergingeconomiesmaystillﬁnditdifﬁculttousethesetechnologiesbecausetheyrequireefﬁcientandgoodinformationinfrastructure.Thealternativewaysofcomplyingmaythusbemoredesirablefromthepointofviewoflargerandforeignbanksastheyarealsolesslikelytobeinvolvedinrelationshiplending.Moreover,foreignbanks,whichdonothavethespeciﬁcknowledgeoflocaldomesticmarkets,couldbedisadvantagedincollectingsoftinformation,whichisvitalinrelationshiplending.

WereportinTable5theaggregatedataonthecompliancetotheMagnaCartaforSmallandMediumEnterprisesoftheuniversalandcommercialbanks(UKBs)overtheperiodofstudy.AlthoughtheUKBscollectivelyallocatemorefundsthantheminimumamounttobeallocatedforSMEs(in2005,19.77%versustherequired8%),anaverageof2.07%alternative/indirectcompliance(tototalnetloanportfolio)indicatesthepresenceofbanksthatdonotcomplybylendingtothesetminimum.ThedistributionofthetotalcredittoSMEs,however,isdisproportionate.Ofthe19.77%compliancetothemandatedcredittoSMEs,9.24%(versus6%required)areallocatedtosmallenterprises,while10.53%(versus2%required)areallottedtomediumenterprises.ItisalsoworthytonotethatfundssetasidetoSMEs,34whichisalsoanotherwaytocomplytotheMagnaCartaforSmallandMediumEnterpriseshasbeenconsistentlyincreasingovertheperiodofstudy.

Becauseoftheorganizationaldiseconomiesofprovidingrelationshiplendingservicesalongwithprovidingtransactionslendingandotherwholesalecapitalmarketservicestolargecorporatecus-tomers,itmaybetoocostlytoprovideﬁnancialservicestosmallﬁrmswhilemaintainingprovisionof

RepublicActNo.6977(lateramendedbyRepublicActNo.8929)–Anacttopromote,developandassistsmallandmediumscaleenterprisesthroughthecreationifaSmallandMediumEnterpriseDevelopment(SMED)Coucil,andtherationalizationofgovernmentassistance,programsandagenciesconcernedwiththedevelopmentofSmallandMediumEnterprises,andforotherpurposes.ItwaslateramendedbyRepublicActNo.9501in2008toincreasethepercentagesetasideforsmallenterprisesfromsixpercent(6%)toeightpercent(8%).33

ThisorganizationisnowknownastheSmallBusinessCorporation.34

ConsistsofeitherCashonHandandDuefromBSPwhicharefree,unencumbered,nothypothecated,notutilizedorear-markedforotherpurposes.TheDuefromBSPisaspecialaccountdepositedwiththeBSPanddoesnotformpartofthebank’slegalreserves.Underthenewmandatorycreditallocation(RA9501)beginning2008,FundsSetAsideisnolongerconsideredasamodeofcompliance.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

117

Table5

AggregateDataontheCompliancewithMicro,SmallandMediumEnterprisesCreditRequiredunderR.A.NO.6977,asAmendedbyR.A.sNos8289and9501ofUniversalandCommercialBanks(UKBs)inthePhilippinesfrom1999to2005(inmillionpesos).

December2005

December2004

December2003December2002183,486

December2001184,862

December2000180,951

December1999174,95927,6995181207,839902,83923.0219.383.07

Micro,smallandmediumenterprisescredit(6%and2%)

154,275163,204163,304Directcompliancefor

MSMEs

14,27714,48913,175Alternative/indirect

ComplianceforMSMEs

FundssetasideforMSMEs11,94611,00310,992

180,498188,696187,471Totalcompliancefor

MSMEs

Totalloanportfolionetof912,867903,565888,287exclusions

19.7720.8821.10Percentageofcompliance

forMSMEs

16.9018.3818.06Percentageofcompliance

forMSMEs(direct)

1.56Percentageofcompliance1.601.48

forMSMEs(alternative)

38,620

7465

8622

9909232,015

7706200,033

6150195,723

798,26429.06

857,07323.34

911,968

21.46

22.99

21.57

19.84

4.84

0.87

0.95

Microandsmallenterprisescredit(6%)DirectcomplianceforMSEs67,583

7311Alternative/indirect

complianceforMSEsFundssetasideforMSEs9444

84,337TotalcomplianceforMSEs

912,867Totalloanportfolionetof

exclusions

9.24Percentageofcompliance

forMSEs

7.40Percentageofcompliance

forMSEs(direct)

0.80Percentageofcompliance

forMSEs(alternative)

72,8547689

75,6326565

103,27218,811

112,8923849

95,8734630

105,49114,0684040123,599902,83913.6911.681.56

845188,994903,565

832390,520888,287

7518129,600798,264

5971122,712857,073

4681105,184911,968

9.85

10.19

16.24

14.32

11.53

8.06

8.51

12.94

13.17

10.51

0.85

0.74

2.36

0.45

0.51

Mediumenterprisescredit(2%)DirectcomplianceforMEs86,693

6966Alternative/indirect

complianceforMEs

2503FundsSetasideforMEs

TotalcomplianceforMEs96,161Totalloanportfolionetof912,867exclusions

10.53Percentageofcompliance

forMEs

Percentageofcompliance9.50forMEs(direct)

0.76PercentageofCompliance

forMEs(alternative)

90,3506800

87,6726610

80,21419,810

71,9703616

85,0783992

69,46813,631114184,240902,8399.337.691.51

255299,702903,565

266996,950888,287

2392102,415798,264

173577,321857,073

146990,539911,968

11.03

10.91

12.83

9.02

9.93

10.00

9.87

10.05

8.40

9.33

0.75

0.74

2.48

0.42

0.44

differentbankingservicestolargeclients(Bergeretal.,2001).Ashifttowardnon-interestincomemaythereforemorelikelybeneﬁtbanksthatarelessinclinedtodirectlycomplywiththeMagnaCartaforSMEsbylending,indicatingtheirexpertiseontheprovisionofotherﬁnancialservicesbesideslending.

Sincewedonothavedetailedinformationwhichprovidesdisaggregateddataofthecomplianceratios35ofindividualbanksisolatingdirectlendingfromalternativecompliance,wegroupbanksaccordingtotheircomplianceratiosthatmayrevealtheirbehaviortowardSMElending.Wegroup

OurdataofthecomplianceratiosoftheMagnaCartaforSMEsofindividualbanksdonotdistinguishdirectcompliancethroughlendingandalternativecompliancethroughseveralmeans.

118

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

Table6A

Theeffectofincomediversiﬁcationonproﬁtabilityandrisk-adjustedproﬁtabilityaccordingtocompliancewiththemandatedcreditprogram,MagnaCartaforSmallFirms.

CompliancetoSMElending(morethanrequired)(Compliance>1.2%MinimumLegalLimit)

CompliancetoSMElending(justwhatisrequiredorless)(Compliance≤1.2%MinimumLegalLimit)

ROA

SHROA

ROA

SHROA−1.553(−0.71)2.744***(3.47)2.032(1.45)0.00003(0.00)4.740(1.15)1.689(1.28)4.102***(2.99)−49.16***(−4.11)

FOCUS1NIIASSETGROWTHEQUITYLOANSGDPConstantR-squaredOBS

0.009(0.69)0.011(0.95)0.056(1.78)−0.009(−1.12)0.150(1.40)0.012(0.97)0.043**(2.55)−0.919**(−2.67)

0.011(0.90)0.056(1.78)−0.010(−1.20)0.146(1.36)0.012(0.97)0.041**(2.87)−0.892**(−2.65)

1.301(0.90)0.811(1.05)4.407**(2.68)−0.622(−0.81)8.590(1.41)−0.227(−0.24)5.366***(3.56)−83.78***(−6.38)

0.788(0.87)4.346**(2.51)−0.718(−0.95)8.035(1.26)−0.202(−0.21)5.058***(3.73)−80.14***(−5.93)

−0.007(−0.37)0.021**(2.07)0.016(1.45)−0.006***(−3.80)0.003(0.06)0.019(1.54)0.020*(1.73)−0.306***(−3.24)

0.023**(2.53)0.017(1.54)−0.006***(−4.05)0.003(0.07)0.019(1.57)0.019*(1.76)−0.316***(−3.17)

3.105***(3.76)2.180(1.54)−0.0281(−0.24)4.824(1.17)1.533(1.25)4.033***(2.92)−51.21***(−4.21)0.27142

0.3668

0.3968

0.37142

0.27142

banksaccordingtotheirlevelofcompliance:(1)banksthatcomplytothemandatedcreditprogrambyholdingmoreSMEloansthanrequiredintheirloanportfolioand(2)banksthatarelendingtoSMEsbecausetheyarerequiredbylaw,andthushavecomplianceratiostotheMagnaCartaforSMEsthatareclosetotheminimum.Thesebanksarealsomorelikelytoalternativelycomplybypurchasingliabilityinstrumentsorsetasidefundsforsmallenterprises36orpaypenaltyfees.Dataoncomplianceratiosforindividualbanksareonlyavailablefrom2005.WeprimarilylookintobankcomplianceratiostotheMagnaCartaforSMEsin2005.Moreover,wecheckthatthecategorizationsarerobustbylookingataveragebankcomplianceratiosfrom2005to2007.Weidentify25bankswhicharelesslikelytocomplythroughdirectlendingand12banks,withcomplianceratiosgreaterthanorequalto1.2%*MinimumLegalLimit(whereMinimumLegalLimit=6%).37WetestHypothesis1onthesetwosubsamples.

TheresultsoftheestimationsareshowninTable6Awhiletheestimatedimpactofashifttowardnon-interestincomeisreportedinTable6B.Intermsofproﬁtability,theﬁndingsindicatethatashifttowardnon-interestincomeincreasesproﬁtability(throughthedirecteffectandneteffect)butonlyforbanksthatalternativelycomplytothemandatedSMElendingprogrambyacquiringdesignatedsecuri-tiesorthosethathavelowlendingexposuretosmallerﬁrms.Conversely,banksthatlendtoSMEsmorethanwhatisrequiredbylawdonotderivegreaterproﬁtsfromshiftingtraditionalinterest-generatingactivitiestonon-interestgeneratingones.TheseresultssuggestthatuniversalandcommercialbanksthatlendmoretoSMEsbeneﬁtlessfromdiversiﬁcation.Moreimportantly,theyhighlightthepres-enceofadditionalopportunitycostsfromlendingtoSMEs,intheformoflostproﬁts,especiallyforthelargerbanksandmostforeignbanksthatdonothaveexpertiseinlendingtosmallbusinesses.Evenwiththepresenceofmandatedcreditprograms,thesebanksmaynothaveincentivestoreallocatetheirfundstowardprioritysectors,suchastheSMEs.

Wefocusourstudyonthemicroandsmallenterprises,wherebankﬁnancingmaybemoreconstrainedcomparedwithmediumenterprises.Inaddition,mostoftheMSMEsinthePhilippinesbelongtothemicroandsmallenterprisesgroup(90%).Itisalsomoreprobablethatbanksalternativelycomplyinthemicroandsmallenterprisesgroupthaninthemediumenterprisesgroup.37

Wealsouseseveralothercoefﬁcientssuchas1.1and1.3andobtainsimilarresults.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

119

Table6B

Estimatedimpactofanincreaseintheshareofnon-interestincomeonproﬁtabilityandrisk-adjustedproﬁtability.

CompliancetoSMElending(morethanrequired)

Compliancetolending(justwhatisrequiredorless)

ROA

SHROA

ROA

SHROA3.1681***(4.22)3.4148***(3.70)3.2059***(4.17)2.9664***(4.18)

Mean25th50th75th

0.008(0.63)0.0055(0.38)0.0073(0.56)0.0102(0.89)

0.4191(0.42)0.0751(0.06)0.3252(0.31)0.7311(0.91)

0.0233**(2.76)0.0244***(2.78)0.0235***(2.78)0.0223**(2.48)

******

Indicatessigniﬁcanceatthe10%level.Indicatessigniﬁcanceatthe5%level.Indicatessigniﬁcanceatthe1%level.

7.2.Listedbanks

Wealsostudytheeffectsofincomediversiﬁcationontherisk,proﬁtabilityandrisk-adjustedpro-ﬁtabilityoflistedanduniversallistedbanksinthePhilippines.Unlikecommercialbanks,universalbanksareallowedtoperformtheactivitiesofinvestmenthouses(RA879138,PD12939)andgenerally,arebiggerintermsofsize.Hence,theimpactofincomediversiﬁcationmaydivergebetweenthetwotypesofbanks.Becauseofascopeandsizeadvantage,wearguethatuniversalbanksareinabetterpositiontodiversifyawayfromtraditionalinterest-generatingactivitiestowardactivitiesthatgener-atenon-interestincome,particularlythenontraditionalones.Wethusstudythelistedanduniversallistedbanks40andtesthypotheses1and2.TheresultsarereportedinTables7and8.Whileweﬁndinbothsubsamplesapositiveandsigniﬁcantdirecteffectofashifttowardnon-interestincomeonproﬁtabilityandrisk-adjustedproﬁtability,thevalueofthecoefﬁcientishigherinthecaseofuni-versallistedbanks.Moreover,intermsofrisk,ourresultssuggestthatuniversallistedbanksderivegreaterrisk-reductionbeneﬁtsfromanincreaseintheshareofnon-interestincomederivesusingmarket-basedindicators.Thisresultisdrivenprimarilybyashifttowardtradingincome,effectivelyincreasingproﬁts,reducingriskandhence,increasingrisk-adjustedproﬁts.

7.3.Componentsoftradingandfee-basedincome41

Wealsoexaminetheeffectsofashifttowardmorespeciﬁc/detailedfee-basedandtradingactiv-ities.WeextendHypothesis2,investigatingfurthertheimpactofashifttowardatraditionaloranontraditionalbankingactivity,whichearnsnon-interestincomeonproﬁtsandrisk-adjustedproﬁts.WhilethismayhavebeenstudiedusingU.S.dataasinStirohandRumble(2006),thisistheﬁrststudyonanemergingeconomythatprovidesmoredetailsonthefee-basedandtradingincomecomponentsofbanks.

RepublicActNo.8791.AnActProvidingFortheRegulationoftheOrganizationandOperationsofBanks,Quasi-Banks,TrustEntitiesandforOtherPurposes.Artcile1,Section23.PowersofaUniversalBank.–Auniversalbankshallhavetheauthoritytoexercise,inadditiontothepowersauthorizedforacommercialbank,thepowersofaninvestmenthourseasprovidedinexistinglawsandthepowertoinvestinnon-alliedenterprises.39

PresidentialDecreeNo.129.TheInvestmentHousesLaw.Section2.Deﬁnitions:A)InvestmentHouseisanyenterprisewhichprimarilyengages,whetherregularlyoronanisolatedbasis,intheunderwritingofsecuritiesofanotherpersonorenterprise,includingsecuritiesoftheGovernmentoritsinstrumentalities.40

Sincetherearenotenoughobservationstoinvestigatecommerciallistedbanks,wecomparealllistedanduniversalbanks.41

Tableofresultsnotreportedbutavailableuponrequestfromtheauthors.

Table7

Incomediversiﬁcationandproﬁtability/riskforPhilippinelistedbanksoverthe1999–2005period(H1).

Listedbanks

Universallistedbanks

ROA

SHROABeta

RiskSpec

TotRisk

ROA

SHROA

BETA

RiskSpec

TotRisk

MZFOCUS1−0.009−1.6280.00020.0490.049−104.8*−0.004−0.413−0.00010.0070.006−65.97(−0.98)(−1.09)(0.14)(0.61)(0.60)(−1.97)(−0.41)(−0.23)(−0.17)(0.38)(0.34)(−1.22)NII0.015**3.029***−0.001−0.050−0.051133.1**0.023***4.086***−0.0006**−0.036***−0.037***137.1**(2.75)(3.77)(−1.30)(−0.77)(−0.77)(2.38)(4.35)(4.49)(−2.41)(−3.92)(−4.00)(3.10)ASSET0.0020.5390.0010.0220.02336.37−0.0144−1.9870.00050.0040.004−29.05(0.15)(0.29)(0.69)(0.21)(0.22)(0.44)(−0.97)(−1.13)(1.18)(0.44)(0.50)(−0.68)GROWTH0.003**0.142−0.001−0.058−0.0590.758−0.00010.0467−0.00003−0.007−0.007**14.52*(0.93)(0.28)(−1.18)(−1.21)(−1.21)(0.04)(−0.02)(0.05)(−0.78)(−2.39)(−2.32)(2.21)EQUITY0.0328.077−0.773**−0.779**−331.40.240**0.244***−0.010**0.0403.4860.004*−375.4(1.17)(1.49)(−2.19)(−2.55)(−2.54)(−1.58)(0.84)(0.35)(1.94)(2.32)(2.34)(−2.20)LOANS−0.007−0.976−0.00010.0060.00620.15−0.031−3.850**−0.0005−0.018−0.018−78.95(−0.46)(−0.59)(−0.12)(0.10)(0.10)(0.20)(−1.67)(−2.71)(−1.23)(−0.95)(−0.91)(−0.91)GDP0.024**5.849***−0.002−0.141−0.143125.30.042***8.686***−0.0001−0.024−0.02581.37(2.40)(3.06)(−0.94)(−1.22)(−1.23)(1.60)(3.74)(7.70)(−0.69)(−1.17)(−1.20)(1.74)Constant

−0.180*−44.7***0.0030.8700.873−1160.9−0.119−35.05−0.0050.1320.129−106.7(−2.06)

(−3.40)

(0.49)

(1.33)

(1.32)

(−0.95)

(−0.87)

(−1.78)

(−1.01)

(0.93)

(0.90)

(−0.30)R-square0.180.280.200.190.190.220.290.370.170.410.410.28OBS

99998686867472

6464

60Waldtest

4.64**9.69***1.62.31.323.65*14.94***10.53***3.58*10.16***10.15***4.83**PartialeffectofNIIonPerf

0.019**

3.78***

−0.001

−0.072

−0.073

180.7**

0.024**

4.28**

−0.001

−0.039**

−0.04**

163.02**

t-statisticsarecorrectedforheteroskedasticityfollowingWhite’smethodology.Variabledeﬁnitions:ROA=returnonaverageassets;SHROA:ratioofreturnonaverageassetstostandarddeviationofROA(annualdata);Beta:marketmodelbeta;TotRisk:totalriskcomputedasthestandarddeviationofweeklyreturns;RiskSpec:speciﬁcriskorthestandarddeviationofthemarketmodelresidual;MZ:MarketZ-score;FOCUS1:focusindexbasedonatwopartoperatingincomebreakdown-non-interestincomeandinterestincome;NII:ratioofnon-interestincometototaloperatingincome;ASSET:logarithmoftotalassets;GROWTH:averageassetgrowth;EQUITY:ratioofequitytototalassets;LOANS:ratioofnetloanstototalassets;GDP:logarithmofthegrossdomesticproduct.*

Indicatessigniﬁcanceatthe10%level.

**Indicatessigniﬁcanceatthe5%level.***

Indicatessigniﬁcanceatthe1%level.

120C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126Table8

Productmixeswithinnon-interestactivitiesandproﬁtability/riskforPhilippinelistedbanksoverthe1999–2005period(H2,model2a).

Listedbanks

Universallistedbanks

ROA

SHROA

Beta

RiskSpec

TotRisk

ROA

SHROA

Beta

RiskSpec

TotRisk

MZFOCUS2−0.015−1.4580.0010.1511.8770.152−87.89−0.0060.00010.0210.020−28.41(−1.16)(−0.62)(0.56)(1.23)(1.22)(−0.87)(−0.21)(0.58)(0.25)(0.99)(0.95)(−0.47)FEE0.016−3.3900.0020.1790.180−47.850.025−1.702−0.0004−0.022−0.023−39.91(0.34)(−0.52)(0.80)(0.78)(0.78)(−0.38)(0.77)(−0.38)(−0.61)(−1.05)(−1.10)(−0.56)TRAD0.0122.922−0.001*−0.006−0.007110.00.025***6.215***−0.001***−0.032***−0.034***153.9**(1.62)(1.71)(−1.87)(−0.11)(−0.12)(1.22)(3.38)(5.53)(−5.33)(−3.79)(−3.92)(2.39)Other−0.027−2.0980.00060.1040.10434.00−0.0033.606−0.00010.0060.00481.28(−0.69)(−0.42)(0.61)(1.61)(1.59)(0.35)(−0.06)(0.89)(−0.23)(0.23)(0.17)(0.93)ASSET0.0040.7770.0010.0320.03338.14−0.014−2.1400.0006−0.001−0.0003−30.98(0.33)(0.39)(0.72)(0.26)(0.27)(0.44)(−0.86)(−1.04)(1.18)(−0.12)(−0.02)(−0.61)GROWTH0.002−0.103−0.001−0.054−0.054−1.371−0.00002−0.120−0.00003−0.006−0.0069.590(0.64)(−0.19)(−1.17)(−1.22)(−1.22)(−0.07)(−0.00)(−0.12)(−0.68)(−1.67)(−1.63)(1.46)EQUITY0.0195.647−0.009**−0.736**−0.742**−376.6*0.0384.5720.0040.234**0.237**−406.7**(0.66)(1.10)(−2.15)(−2.54)(−2.53)(−1.76)(0.71)(0.50)(1.80)(2.34)(2.36)(−2.63)LOANS−0.006−1.2600.000020.0070.00730.02−0.034**−4.898***−0.0004−0.021−0.020−86.00(−0.52)(−0.69)(0.02)(0.11)(0.12)(0.28)(−2.47)(−4.57)(−1.01)(−1.08)(−1.01)(−0.99)GDP0.026*5.379**−0.002−0.143−0.145106.10.046**8.394***−0.0002−0.020−0.02165.58(1.96)(2.54)(−0.87)(−1.17)(−1.17)(1.74)(2.97)(4.82)(−0.83)(−1.00)(−1.04)(1.62)Constant

−0.21**−42.64***−0.0010.6790.679−1028.9−0.142−31.76−0.0050.1480.14433.17(−2.21)(−3.01)(−0.10)(0.89)(0.89)(−0.83)(−0.97)(−1.50)(−0.94)(1.13)(1.08)(0.09)R-square0.240.370.230.210.210.220.350.480.200.440.4370.317OBS

96968484847270

6262

Waldtest

4.36**9.03***1.861.961.943.01*39.13***15.96***9.68***23.98***24.26***13.71***PartialeffectonPerf:

0.019**

3.78***

−0.001

−0.072

−0.073

180.7**

0.024**

4.28**

−0.001

−0.039**

−0.04**

163.02**

t-statisticsarecorrectedforheteroskedasticityfollowingWhite’smethodology.Variabledeﬁnitions:ROA:returnonaverageassets;SHROA:ratioofreturnonaverageassetstostandarddeviationofROA(annualdata);Beta:marketmodelbeta;TotRisk:totalriskcomputedasthestandarddeviationofweeklyreturns;RiskSpec:speciﬁcriskcomputedasthestandarddeviationofthemarketmodelresidual;MZ:MarketZ-score;FOCUS2:focusindexbasedonafourpartoperatingincomebreakdown-fee-basedincome,tradingincome,othernon-interestincome,andinterestincome;FEE:ratiooffee-basedincometototaloperatingincome;TRAD:ratiooftradingincometototaloperatingincome;Other:ratioofothernon-interestincometototaloperatingincome;ASSET:logarithmoftotalassets;GROWTH:averageassetgrowth;EQUITY:equitytototalassets;LOANS:ratioofnetloanstototalassets;GDP:logarithmofthegrossdomesticproduct.*

Indicatessigniﬁcanceatthe10%level.

**Indicatessigniﬁcanceatthe5%level.

***

Indicatessigniﬁcanceatthe1%level.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126121122

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

Weconstructtwonewmeasuresthattakeintoaccounttheseparatecomponentsoffee-basedandtradingincome.Werunanewsetofregressionsonthebasisofthefollowingmodels:

Yit=˛it+ˇ1FOCUS3it+ˇ21BCit+ˇ22SCit+ˇ23OCit+ˇ3TRADit+ˇ4Otherit+Zit+εit

(13)

Yit=˛it+ˇ1FOCUS4it+ˇ2FEEit+ˇ31GSit+ˇ32PDit+ˇ33FFit+ˇ34PIit

+ˇ35FPit+ˇ4Otherit+Zit+εit

(14)

FOCUS3itandFOCUS4itaremeasuresofdiversiﬁcationwithinrespectivelydetailedfee-basedandtradingincomes;BCit,SCitandOCitarethethreecomponentsoffee-basedactivitiesandrepresentthesharesof,respectively,bankcommissions,servicechargesandothercommissionsintotaloper-atingincome.GSit,PDit,FFit,PIit,andFPitaretheﬁvecomponentsoftradingactivitiesandrepresentthesharesof,respectively,governmentsecuritiestradinggains(losses),privatedebttradinggains(losses),ﬁnancialfuturesgains(losses),andproﬁtfrominvestmentandforeignexchangeproﬁtsintotaloperatingincome.

IncontrastwithChiorazzoetal.(2008),weﬁndthatgainsfromdiversiﬁcationareassociatedwiththesourceofnon-interestincome.OurﬁndingsarenotinlinewithstudiesonU.S.banks(i.e.Stiroh,2004b)whichreporthigherriskforbanksmorereliantontradingactivities.However,forEuropeanbanks,Lepetitetal.(2008a)donotﬁndevidenceofapositiverelationshipbetweentradingactivitiesandrisk.

Theeconometricinvestigationconductedonthedetailedbreakdownoffee-basedandtradingactivitiesprovidesaclearerinsightofhowdifferentproductmixeswithinnon-interestactivitiesaffectproﬁtabilityandrisk.Twomainresultsarehighlighted.First,inthecaseoffee-basedactivities,weﬁndthatanincreasedshareof“othercommissionsandfees”tototaloperatingincomeisassociatedwithincreasedproﬁtabilitybutnotrisk-adjustedproﬁtability.Hence,althoughashifttowardnontraditionalfee-generatingactivitiesofbanksraisesproﬁts,arisk-returntradeoffexistswhereintheproﬁtincreasemayhavebeenoffsetbyanincreaseinreturnvolatility.Thisresultistheoreticallysoundasrevenuesderivedfromnon-relationshipbasedfee-generatingactivitieswithhighsensitivitytothebusinesscyclesuchasinvestmentbankingcanbemorevolatilethanrevenuesfromtraditionalrelationship-basedbankingactivities(DeYoungandRice,2004).Thesecondresultrelatestotradingincome.Weﬁndthatashifttowardtradinggovernmentsecuritiesandﬁnancialfutures/options/forward/swaps,bothnontraditionalbankingactivities,leadtoenhancedproﬁtabilityandrisk-adjustedproﬁtability.AsdiscussedinSection3.1,thedevelopmentsinthecapitalmarketduringthestudyperiodsuchastheoperationofPhilPaSSandFixedIncomeExchangeandthecontinuousdeclineindomesticinterestratesmayaltogetherhavefueledinvestors’appetiteforgovernmentsecurities.Theseinitiativesalto-gethercontributetotheexpectedproﬁtsofuniversalandcommercialbanks,whichcanbeauthorizedgovernmentsecuritiesdealers.OversubscriptionsingovernmentsecuritieshavebeenparticularlydocumentedintheauctionsconductedbytheBureauofTreasuryduring2000–2005period.42

FurtherdifferencesinthediversiﬁcationeffectofPhilippinebanksintonon-interestactivitiesareanalyzedbyexaminingthespeciﬁccaseofuniversalbanks,whichunlikecommercialbanks,areallowedtoperformtheactivitiesofinvestmenthouses(RA8791,43PD12944).Followingexistingstud-ies(BhargavaandFraser,1998;AkhigbeandWhyte,2004;Cornettetal.,2002)whichexaminetheeffectsofvariousregulationsthatpertaintobankexpansionintoinvestmentbankingactivities,ouraimhereistoassesstheriskimplicationsofdiversifyingintosuchspeciﬁcnon-interestactivities.Weinves-tigatetheeffectsofthedisaggregatedsharesoffee-basedandtradingincomeontheriskofuniversal

InﬂationReportsSecondQuarter(2003,2005),BangkoSentralngPilipinas.

4243

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

123

banksandfocusmoreparticularlyontheeffectofincreasedsharesin“othercommissions/fees”(acom-ponentoffee-basedincome),whicharecommissionandfeescollectedforinvestmenthouseactivitiessuchasunderwriting,securitiesdealershipandequityinvestments,thenontraditionalincomecom-ponentoffee-basedactivities.Ourresultsshowthatinthecaseofuniversalbanks,ashifttowardinvestmenthouseactivities,althoughleadingtohigherproﬁts,hasanadverseeffectonrisk.Thisisconsistentwithsomestudiesondevelopedcountriesthatﬁndshiftstowardfee-basedactivitiestoberisky.Fee-basedincomeearnedfromtheinvestmenthousefunctionsare,however,smallcom-paredtootherfee-basedcomponents.Lookingfurtheronthedisaggregationoftradingincome,weﬁndthathigherinvolvementintradinggovernmentsecuritiesleadstoriskreduction,enhancingbothproﬁtabilityandrisk-adjustedproﬁtability.

8.Robustnesschecks45

Wealsoperformseveralrobustnesschecks.First,wedeﬁnealternativemeasuresofdiversiﬁcation,particularlyFOCUS1.Astheindexpredictsthesamedegreeoffocusforbanksthataremorereliantoninterestincome,andforthosethataremoreorientedtowardnon-interestincome,itdoesnotallowustodifferentiateonwhichactivitiesthebankisfocusedon.Wethendeﬁneanotherindicator,FOCUS-DIV,whichistheinteractiontermofFOCUS1withadummyvariable,DIV,whichisequalto1iftheshareofnon-interestincomeishigherthan50%andzero,otherwise.ThecoefﬁcientofFOCUSDIVindi-cateswhetheritpaystobemorefocusedonnon-interestactivitiescomparedtointerest-generatingones.WealsoexaminedifferentthresholdsofDIV–30%,40%and60%andﬁndthatatathresholdofnon-interestincomelessthan40%,focusonnon-interestincomedoesnottranslateintoincreasedbankproﬁtability.Moreover,withthresholdsgreaterthan40%,weﬁndthatfocusincreasesbankpro-ﬁtability.Ourresultsareveryrobusttothe60%and70%thresholds,whichconﬁrmthatfocusinginactivitiesthatgeneratenon-interestincomeincreasestheproﬁtabilityofPhilippinebanks.

Second,weuseamorelimiteddeﬁnitionoftradingincome,whichincludesonlythegains/lossesfromtradingactivities(governmentsecurities,private/equitysecurities,andﬁnancialfuturesoptions/forwards/swaps).Whenthisdeﬁnitionisused,weﬁnd“othernon-interestincome”tobepositivelyrelatedtoproﬁtabilityandrisk.Thiscanbeexplainedbytheinclusionofothernontradi-tional,non-interestincomegeneratingactivitieslikeforeignexchangeproﬁt,goldtradinggain/lossandtheproﬁtonsaleorredemptionofinvestmentsinourdeﬁnitionof“othernon-interestincome”,drivingupdiversiﬁcationbeneﬁts,notablyrisk-adjustedproﬁtability.Theresultshoweverregardingtradingincomeremainunchanged.

Wealsoexamineiftherearesigniﬁcantbehavioraldifferencesbetweenlistedandnon-listedbanks.Wedonotﬁnd,however,signiﬁcantdifferencesoverthesetwosubsamples.

9.Summaryandconcludingremarks

Researchonbankrevenuediversiﬁcationindevelopedcountries,namelytheU.S.,hasdocumentedthatahigherrelianceonnon-interestactivitieslowersrisk-adjustedproﬁts(Stiroh,2004a,2004b,2006;StirohandRumble,2006).Inthispaper,weﬁnddiversiﬁcationtobebeneﬁcialforPhilippinebanks,consistentwithexistingstudiesonemergingcountries(SanyaandWolfe,2011;Pennathuretal.,2012;Nguyenetal.,2012).Philippinebankshaveadifferentnon-interestincomestructure.ForanaveragePhilippinebank,theshareoftradingactivitiesinnon-interestincomeisrelativelyhighercomparedwithanaverageU.S.bank.Whereasmostofthefee-basedincomeisobtainedfromtradi-tionalbankintermediationactivities,tradingincomeisnontraditionalasitsgrowthislesscorrelatedwithnetinterestincomegrowth.Fromastandardportfolioapproach,thismayindicatethattheremaybehigherdiversiﬁcationbeneﬁtsfromshiftstowardtradingactivitiesratherthanshiftstowardfee-basedactivities.Ourempiricalresultssupportthishypothesis,suggestingthatthatshiftstoward

Forthesakeofbrevity,wedonotreportalltheresultsdiscussedunderthesectionofrobustnesscheck.However,theresultsareavailablefromtheauthorsonrequest.

124

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

tradingactivities,particularlyfromtradinggovernmentsecurities,leadtohigherbankproﬁtsandrisk-adjustedproﬁts.

Wealsoexaminehowbankownershipmayaffecttheincomediversiﬁcation–performancerelation-ship.Ourﬁndingsindicatethatforeignbankshavetheupperhandindiversifyingincomecomparedwithdomesticbanks.Asforeignbankstendtospecializeinnon-interestactivities,amarginalincreaseinnon-interestincometendstoincreasefurthertheirrisk-adjustedproﬁts.Inemergingcountries,for-eignbanksgenerallysufferfrominsufﬁcientknowledgeofthelocalmarketanddisadvantageintermsofcollectingsoftinformation,whichmaybevitalinlendingnotonlytosmallbusinessesbutalsotolargerﬁrms.Thusitpaysforthemtospecializeinnon-interestincomegeneratingactivitiesratherthantraditionalintermediationactivities.

Wetakeourinvestigationdeeperbytacklingaspeciﬁcregulatoryaspectthatisakintoemergingeconomies–thepresenceofmandatedcreditprogramstoSMEs.Inordertoaddresslimitedaccesstoﬁnance,whichconstrainsSMEgrowthandexpansioninthePhilippines,thegovernmenthasimposedaminimumamountofbanklendingtoSMEs.Weﬁndrevenuediversiﬁcation,moreprecisely,ashifttowardnon-interestincometobeneﬁtbanksthatlendlesstoSMEs.Thisresultsuggeststhatforthesebanks,thepresenceofanadditionalopportunitycostintheformoflostproﬁtsfurtherdissuadesthemtodirectlylendtoSMEs.Theexistenceofalternativewaystocomplywiththeregulation,i.e.byacquiringspeciﬁcgovernmentsecurities,mayhavehastenedbankinefﬁciencygenerallyattributedtomandatedcreditprogramsbutattheexpenseofthesocialpurposeofsuchdevelopmentprogramsthataimtoincreasesustainableaccesstoexternalﬁnancetoSMEs.BanksthatallocateahigherpercentageoftheirloanportfoliotoSMEsareassumedtohaveappropriatelendingtechnologiesthataddressopaquesmallbusinessborrowersandrelativelylessexpertiseindiversifyingintonon-interestactivi-ties,whichmayarisebecauseofhighswitchingcosts.AsreportedbytheWorldBank(2013),insteadofencouragingSMEdevelopment,suchlendingrequirementhasledtore-labelingorre-categorizingofloansinordertocomplywiththerequirementinsteadofincreasingtheiroutreachtonewSMEclients.HenceasystemofcreditguaranteesmaystandabetterchanceofsuccessfullyincreasingSMEaccesstoexternalﬁnancethanthecurrentsystem.Onthewhole,ourﬁndingshighlightthatthedevelopmentofnontraditionalintermediationactivitiesinbankinghavedifferentimplicationsintermsofproﬁt-abilityandriskinthecaseofanemergingeconomy.Speciﬁcally,bankownership(foreign/domestic)andtheengagementinSMEfundingaswellasthepresenceofspeciﬁcregulationstopromotesmallscalelendingmatter.

Acknowledgements

Theauthorsgratefullyacknowledgetheinsightfulcommentsofananonymousreferee.TheyaregratefultoBSP-SupervisoryDataCenterandMariaSocorro-GochocoBautistaforprovidingdata.Theyalsothankparticipantsofthe2010MidwestFinanceAssociationConference,the2010GdRE“Money,BankingandFinance”AnnualConference,andthe2011FinancialManagementAssociationAnnualMeeting.

AppendixA.Deﬁnitions

A.1.Non-interestincomeaccounts

Fee-basedincome:sumofbankcommissions,servicecharges/feesandothercommissions/feesBankcommissions:commissionscollectedforservicesrenderedasin:(a)openingoflettersofcredit,(b)handlingofcollectionitems,domestic/export/importbillsandtelegraphictransfers,and(c)saleofdemanddrafts,traveller’schecksandgovernmentsecurities

Servicecharges:charges/fees,includingcommitmentfees,collectedforservicesrenderedasin:(a)handlingofloansandtransactionsandreturnedchecks,(b)saleofmanager’schecks.

Fees/commissions(others):feesandcommissionsearnedandcollectedforservicesrenderedinconnectedwiththeinvestmenthousefunctionsofthebanksuchasunderwriting,securitiesdealershipandequityinvestments.

C.Meslieretal./Int.Fin.Markets,Inst.andMoney31(2014)97–126

125

Tradingincome:sumoftradinggainfromgovernmentsecurities,privatesecurities/commercialpapers/equitysecurities,ﬁnancialfutures/options/forwards/swaps;foreignexchangeproﬁt/loss,goldtradinggain/loss;proﬁtonsaleorredemptionofinvestments.

Tradinggain(governmentsecurities):gainorlossongovernmentsecuritiestradedinmoneymarketoperations.

Tradinggain(privatesecurities/commercialpapers/equitysecurities):gainorlossinprivatesecurities/commercialpapers/equitysecuritiestradedbythebank.

Tradinggain(ﬁnancialfutures/options/forwards/swaps):tradingproﬁtsandloss(bothrealizedand“mark-to-market”)arisingfromﬁnancialfutures/options/forward/swaptradingtransactions.Foreignexchangeproﬁt:realizedproﬁtoractuallossincurredonforeignexchangetransactions,includingproﬁtorlossarisingfromtheadjustmentofthepesoequivalentofforeignmonetaryaccountsconsistingofforeigncurrenciesonhand,duefromforeignbanksandshort-termreceivables/payables.Proﬁtonsaleorredemptionofinvestments:proﬁtsearnedorlossincurredonthesaleorredemptionofinvestments.

Othernon-interestincome:sumofincomefromtrustdepartmentandotherincome

Income(trustdepartment):commissionsandotherincomeearnedandcollectedorlosssufferedbythebank’strustdepartmentinthehandling/administrationoftrustaccounts.Otherincome:rentalincomeandmiscellaneousincome.

(Source:ManualofAccountsforUniversalandCommercialBanks,CentralBankofthePhilippines)

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Is bank income diversification beneficial Evidence from an emerging economy