8 The return of small banks in contrast was much more stable Overall the

8 the return of small banks in contrast was much more

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non-performing loans and loss provisions in Table 2. 8 The return of small banks, in contrast, was much more stable. Overall, the descriptive analysis suggests that large banks have more volatile returns, and therefore, seem to be more risky than small banks. Small banks, in contrast, have more stable returns, but are also 8 Please note that these results should be interpreted with caution, since they might be driven by differences between national definitions of impaired assets (non-performing and doubtful assets) and provisions. 6 8 4 2 0 –2 –4 –6 –8 2008 –10 –12 uni00A0 uni00A0 uni00A0 All institutions Large institution Medium-sized institution Small institution 2009 2010 2011 Figure 2: Return-on-equity (ROE) Source: ECB (2013). Figure shows the development of the return-on-equity (ROE) between 2008 and 2011 for small, medium-sized and large banks in the E.U. Small banks have assets of less than €1b. The assets of medium-sized banks range from €1b to €100b. Large banks have assets of more than €100b.
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9 The Journal of Financial Perspectives less profitable than large banks, which is consistent with the view that retail banking is a relatively stable, but also low-return, activity [Hirtle and Stiroh (2007)]. It should be noted that there were also small banks that reported large losses during the financial crisis. These banks were mostly specialized in mortgages and considerably increased their lending in the pre-crisis period. 9 Furthermore, not all large banks performed badly, relatively. Some large and more retail-oriented banks were also less affected by the crisis. 10 This indicates that it is not necessarily the size that matters for bank risk, but rather the extent to which banks diversify their activities. 4.2 Literature on income diversification in banking The previous section indicated that levels of diversification might have an important influence on bank risk and return. To further investigate this hypothesis, we now take a closer look at the academic literature on diversification in banking. This literature usually examines the impact of geographic and income diversification on bank risk and return. In this paper, we focus on the literature on income diversification. 11 This literature analyzes whether the expansion into non-traditional activities has made banks more stable and allowed them to generate higher returns. Theoretically, the benefits of income diversification are appealing. Owing to a better diversified income structure, banks are able to recoup losses in some business areas through alternative sources of revenue in other areas. For example, by expanding into investment banking, banks can offset declining revenues in retail banking. This should lower the volatility of returns and lead to higher risk-adjusted returns. In theory, therefore, diversification into non-interest income activities, such as investment banking and trading, is beneficial for banks.
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