Financial Stability Through Bank Diversification
The banking industry of the United States of America is witnessing a major shift in the revenue making procedures. The banks are now inclined towards generating income from non-interest-based sources such as fee income, service charges and trade revenue etcetera instead of the traditional process of loan making. Noninterest income has always played an influential role in the revenue generation of the banking system. It'd evident from the fact that by the year 2000 the noninterest income accounted for forty three percent of the total banking revenue which is a massive rise from the twenty five percent in the year 1984.[footnoteRef:2] (Stiroh, 2004) [2: Kevin Stiroh, 2004. "Diversification In Banking: Is Noninterest Income The Answer?" Journal of Money, Credit and Banking 36(5), 853-882]
According some scholars, the shift in the revenue generation process, on the one hand, has led towards an evident increase in the revenue of the banking system in the recent times and on the other hand, it has also led towards a reduction in the volatility of the profitability and revenue of the system and has also reduced the risk that is associated with the banking industry. This might be due to the reason that the channels of non-interest income depend less on the overall business conditions of the economy, whereas, the channels of interest income rely heavily on the overall business conditions of the economy. Therefore, an increased dependence on generating revenue through noninterest income channels has led towards a reduction in cyclical variations in the revenue generation of the banking system. [footnoteRef:3] (Stiroh, 2004) [3: Kevin Stiroh, 2004. "Diversification In Banking: Is Noninterest Income The Answer?" Journal of Money, Credit and Banking 36(5), 853-882]
In addition to that, the expanded product lines and the cross selling opportunities that are linked with the non-interest income channels offer the banks with efficient diversification benefits in relation to the revenue portfolio of the banks. In other words, the non-interest income has the ability to improve the risk/return tradeoff of the banks and to diversify the revenue portfolio of the banks. The ability of the non-interest income channels to reduce risk is given great importance by the individual banks and the supervisors and the regulators of the banking system as well. [footnoteRef:4] (Stiroh, 2004) [4: Kevin Stiroh, 2004. "Diversification In Banking: Is Noninterest Income The Answer?" Journal of Money, Credit and Banking 36(5), 853-882]
Characteristics That Enables the Banks to Stay Stable during Financial Crisis
The financial crisis that began in the year 2007 and intensified in the year 2008 affected all the banks in a negative manner and led towards the dissolution of a number of banks. As the housing bubble burst it forced a number of banks to write of loans amounting to millions of dollars. The factors that led towards the development and creation of the housing bubble are as follows;[footnoteRef:5] (Brunnermeier, 2009) [5: Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008." Journal of Economic Perspectives 23, 77-100]
The economy of the United States of America was experiencing low interest rates as there was a large inflow of investment from foreign countries and the Federal Reserve had also opted for a lax policy.[footnoteRef:6] (Brunnermeier, 2009) [6: Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008." Journal of Economic Perspectives 23, 77-100]
The Asian countries were continuously investing in the U.S. securities in order to peg the exchange rate at a level that would be export friendly. In addition to that, they also aimed at reducing the continuous depreciation of their currencies in relation to the U.S. Dollar.[footnoteRef:7] (Brunnermeier, 2009) [7: Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008." Journal of Economic Perspectives 23, 77-100]
The traditional banking system went under transformation and was converted to an 'originate and distribute' system. In this system the loans were being pooled, and then they were divided into small portions and were then sold through the process of securitization. [footnoteRef:8](Brunnermeier, 2009) [8: Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008." Journal of Economic Perspectives 23, 77-100]
The Federal Reserve was concerned about the deflationary period that might have followed the bursting of internet bubble and hence did not pay much attention to the development of housing bubble and as a result no counter strategy was designed against the development and creation of housing bubble.[footnoteRef:9] (Brunnermeier, 2009) [9: Markus K. Brunnermeier, 2009. "Deciphering the Liquidity and Credit Crunch 2007-2008." Journal of Economic Perspectives 23, 77-100]
When the pre-crisis balance sheets of a number of banks analyzed...
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