A comparative study on bank income diversification: which non-interest income component is beneficial?
| Date | 04 June 2024 |
| Pages | 49-74 |
| DOI | https://doi.org/10.1108/JCEFTS-12-2023-0065 |
| Published date | 04 June 2024 |
| Author | Rania Pasha,Israa Lewaaelhamd |
A comparative study on bank
income diversification: which
non-interest income component
is beneficial?
Rania Pasha and Israa Lewaaelhamd
Business Department, Faculty of Business Administration, Economics and Political
Science, The British University in Egypt, Cairo, Egypt
Abstract
Purpose –This paper aims to conductacomparative studyon the impact of income diversification and the
main non-interest components on banks’financial performance and risk-adjustedprofitability in China and
Egypt.
Design/methodology/approach –This study uses both static and dynamicpanel regression analyses
on a sample of Egyptianand Chinese banks from 2009 to 2022.
Findings –Income diversificationyields positive effects on bank profitability in Egypt and China.Trading
income consistentlyexhibits a significant positive influence on bankprofitability in both nations. Conversely,
fee-based income positively impacts bank profitability in China, whereas in Egypt, this effect is observed
under dynamic-based regression models. On the contrary, income diversification does not consistently
increaserisk-adjusted profitability in both countries,especially Egypt.
Originality/value –Tothebestoftheauthors’knowledge, this is the first study to examine the impact of
income diversification on Egyptianbank performance while identifying the most significant non-interest income
components. In addition, the comparative analysis conducted in this study reveals thepositioning of China, the
largest economy among emerging countries, in terms of the degree of incomediversification, its impact on bank
profitability and the extent to which non-interest income components contribute to bank profitability when
compared with Egypt, representing an emerging country characterised by different levels of bank market power,
financial infrastructure and expertise. Findings hold significant implications, suggesting that bank managers
and policymakers should prioritise diversifying income sources, particularly through fee-based services and
trading activities in China, and trading activities in Egypt,to enhance financ ial profitability.
Keywords Emerging markets, Income diversification, Bank profitability,
Risk-adjusted profitability, Panel data analysis, Emerging markets,
Paper type Research paper
1. Introduction
In the contemporary financial sector, marked by globalisation, heightened competition and
economic crises, the banking sector, both in developing and developed nations, has
witnessed profound transformations in recent decades. The 2008 global financial crisis,
originating from the US subprime mortgage crisis, had far-reaching impacts on the world
economy and financial systems. Thisevent underscored the need for worldwide attention to
banks’financial risk management, with an emphasis on both risk prevention and
diversificationstrategies (Wang et al.,2023). Consequently, bank managers’focusnowadays
extends beyond banks’risk definition, measurement and formation analysis; it entails a
more precise focus ondiversification.
Non-interest
income
component
49
Journalof Chinese Economicand
ForeignTrade Studies
Vol.17 No. 1, 2024
pp. 49-74
© Emerald Publishing Limited
1754-4408
DOI 10.1108/JCEFTS-12-2023-0065
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1754-4408.htm
Banks are showing a growing inclination towards diversifying their income sources to
enhance profitability and reduce risk. They are actively engaged in new revenue streams
and expand their asset portfolios, which may include investment provision, brokerage
services, stock trading and underwriting services (Meslier et al., 2014;Uddin et al.,2022).
Banks have been actively diversifyingtheir revenue streams to seek new sources of income
growth in response to diminishing margins in traditional retail lending. An anticipated
outcome of this diversification strategy is the potential increase in the proportion of non-
interest income (NII) within banks’total earnings, which could, in turn, contribute to
reducing the cyclicality of their overall income. Consequently, it is reasonable to anticipate
that NII activities may prove advantageousfor banks in mitigating risk, particularly in the
context of the recent global crises.
The recent global crises, COVID-19 pandemic and the Russian–Ukraine conflict, posed
considerable challenges for nations and led to a significant economic slowdown, impacting
banks and causing a decline in their conventional lending operations (Hassan et al.,2022).
The COVID-19 pandemic has driven the implementation of various restrictions such as
social distancing measures, travel bans and the closure of non-essential businesses.
Consequently, these measures had adverse effects on the operational performance of
businesses across all sectors. In addition, households had been impacted by job losses and
reduced income, resulting in challenges in servicingtheir debts and heightening the risk of
default. This has accelerated the drawdownofcredit lines, particularly among riskier firms,
thereby damaging bank balance sheets and reducing their capital adequacy ratios. Such
developments posed threats to the stabilityof banks and impeded their ability to facilitate
future financialintermediation (Shabir et al.,2023).
As global economies beganto recover from COVID-19 consequences, the Russia–Ukraine
War provided a new shock to global financial markets. Considering its sensitivity to
business cycles and exogenous market shocks, the banking sector faced severe
repercussions resulting from the Russian–Ukraine conflict. This conflict involveseconomic
sanctions targeting oil, one of the world’s most valuable commodities, and leads to
disruptions in the global food and oil supply chain(Batten et al.,2023). In addition, according
to Girardone (2022), the financial sanctionsimposed on Russia led to a very sharp decline in
the number of banks in Russia, along with the exclusion of Russian banks from the
international banking system, potentially triggering massive withdrawals from them. In
addition, the war resulted in a rise in credit default swaps representing high risk on the
international banking system. Consequently, the impact of Russian–Ukraine conflict that
triggered geopolitical risks, sanctions and countersanctions have extended beyond the
regional economic sphere and affected the international banking sector for both developed
and developing countries(Yudaruddin and Lesmana, 2023).
As a result, both the COVID-19 pandemic and Russian–Ukraine war, as exogenous
shocks, have not only directly impacted the functioning of banking systems but have also
indirectly affected banks’performance by influencing household incomes and business
revenues. Ho et al. (2023) asserted that such exogenous shocks increase non-performing
loans and diminish banks’profits, solvency and capital. Drawing on a comprehensive data
set encompassing 1,231 banks across 90 countries, Ho et al. (2023) investigated whether
diversified banks were better equipped to withstand the recent disruptions in the banking
sector. Their findings suggest that NII appears to have a favourable connection to
profitability and stability, aligning with the observations of Simoens and Vander Vennet
(2021), who argue that bank diversification serves as a significant shock absorber.
Consequently, embracing diversification by banks serves as a strategic response, enabling
them to generate income even amidst global crises, thereby reducing bank risk and
JCEFTS
17,1
50
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