Product Diversification in the European Banking Industry: Risk and Loan Pricing Implications

Abstract

The purpose of this paper is to investigate the relationship between bank risk and product diversification in the changing structure of the European banking industry. Based on a broad set of European banks for the period 1996-2002, our study shows that banks expanding into non-interest income activities present higher risk than banks which mainly supply loans. Whereas previous studies (mainly on U.S. banks) focused on portfolio diversification effects we explore risk implications of cross-selling determinants of loan pricing as an alternative explanation. Our results show that higher income from other activities is associated with lower lending rates which suggests that banks may actually use loans as a loss leader altering default screening and monitoring activities and consequently risk pricing