For the sake of profits! Banks' risk-adjusted profitability and its volatility with customers' quality (conference proceeding)

Abstract

<p> We investigate the banks’ concentration of credit to small businesses and product diversification on their risk-adjusted profitability and its volatility. Analyzing 4,280 observations about the relationships between small banks and small businesses in the period 2001-2005 we provide customer-level evidence of the adverse objectives of individual banks and the banking system. We find that banks’ risk-adjusted profitability based on concentration of credit increases significantly with the quality of the customer, while that of product diversification decreases with the quality of the customer. Furthermore, the volatility of banks’ profits depends on customer quality: in the low-end of customer qualities the volatility of profits is substantially higher than the corresponding risk-adjusted profitability. The results suggest that profit-generating mechanisms of individual banks serving customers of different qualities may perform adversely compared to the interest of community or the banking system, per se. In small business lending the consequences of an individual mix of services that perform similarly because of common characteristic is considerable risk to banks’ earnings and capital.</p>