74th International Atlantic Economic Conference

October 04 - 07, 2012 | Montréal, Canada

The rise and fall of universal banking

Friday, October 5, 2012: 5:15 PM
Sergio Masciantonio, MSc , Monetary Policy and Economic Outlook Department, Bank of Italy, Rome, Italy
Andrea Tiseno, PhD , Bank of Italy, Rome, Italy
The Rise and Fall of Universal Banking: ups and downs of a sample of large and complex financial institutions since the late 90’s 

Sergio Masciantonio and Andrea Tiseno 

May 2012

We document the development of the banking sector since the late nineties (1999-2011), reporting balance sheet developments for 27 large and complex financial institutions. We use quarterly data presented on a yearly basis. We argue that the deregulation of the banking sector paved the way to the rise of the universal banking model and show how this model was plunged by the global financial crisis.

From late nineties, banks enormously grew in size, mainly through increasing leverage and consolidation within the sector. Moreover they diversified their business model towards riskier and more profitable activities and increasingly relying on wholesale funding. These changes have been sharper and quicker for European banks, which were traditionally more retail-oriented. North-American banks showed a less pronounced pace of change; given their higher reliance on investment banking since the start of the period under review.

This model was apparently sound and efficient in the run-up to the crisis, showing a constant growth in profitability, but highlighted all its shortcomings when the crisis erupted. Profitability dropped sharply, stabilizing to negative levels for several quarters. Huge losses arose in loan portfolios and in trading activities, leaving aside write-downs of toxic assets. European banks highlighted greater fragilities in their business models than their North-American counterparts. Moreover the changed financial and regulatory landscape that followed has challenged this model further.

Excessive leverage was considered among the main weaknesses of the dominant model. Regulatory authorities pushed for increases in the capital bases in order to force banks to deleverage. We show some empirical evidence, through some panel regressions, of how this deleveraging trend reduces the profitability, further challenging banks’ ability to return to their pre-crisis business model and level of profitability. Moreover the breakdown of the interbank market led to a costly hoarding of unallocated liquidity. Finally, many proposed remedies to the global financial crisis appear to push for a return of a narrower model for banking activity.

JEL classification: G21, G01

Keywords: banks, banking crises, financial crises, balance sheets