Non Interest Income of Banks: Diversification and Consolidation

Why has Net interest income declined over the years? Particularly between 1980 – 2000

Why has Non Interest Income increased over the years? Particularly between 1980-2000


net interest income2


Mergers, Consolidation, Bank Failures, Diversification, Deregulation, Competition

Merger activity and overall consolidation are of particular interest in the U.S. banking industry. Since 1980, the structure of the U.S. banking industry has changed considerably, with over 10,000 mergers involving more than $7 trillion in acquired assets taking place. Furthermore, the number of institutions has declined dramatically over this period, and the concentration of assets held by the largest institutions has increased. There were 19,069 banks and thrifts operating in the U.S. in 1980 and 7,011 in 2010, a decline of over 60 percent. In 1980, the 10 largest banking organizations held only 13.5 percent of banking assets, increasing to 36 percent by 2000. By 2010, the 10 largest organizations held approximately 50 percent of banking assets. 

Changes in Regulation

The banking industry has undergone significant regulatory changes in the past 15 years. These regulatory changes have had significant effects on competition and structure, with some changes acting as the impetus for recent merger waves. For example, the Riegle–Neal Interstate Banking and Branching Efficiency Act of 1994 allowed branch banking beyond one state and throughout the United States, and the Gramm–Leach–Bliley Act of 1999 (Financial Services Modernization Act) allowed banks to enter other financial markets and provide additional financial services. Both of these laws are potential causes for the increase in bank mergers. With such regulatory changes and the overall changes in the bank industry structure, banking has moved from a fragmented industry with banks operating only in individual states to a more unified industry, dominated by banks operating in large regions of the country.

Growth through Diversification (Product Mix):

From Banks’ Non-Interest Income and Systemic Risk:

However, prior the crisis, banks have increasingly earned a higher proportion of their profits from non-interest income compared to interest income. Non-interest income includes activities such as income from trading and securitization, investment banking and advisory fees, brokerage commissions, venture capital, and fiduciary income, and gains on non-hedging derivatives. These activities are different from the traditional deposit taking and lending functions of banks. In these activities banks are competing with other capital market intermediaries such as hedge funds, mutual funds, investment banks, insurance companies and private equity funds, all of whom do not have federal deposit insurance.

From Non interest Income and Financial Performance at U.S. Commercial Banks

Much of the empirical literature in commercial banking has followed these rich theoretical leads, analyzing the financial flows fundamental to the intermediation process (e.g., interest paid on deposits, interest received from loans and securities, and the resulting net interest margins) and the risks associated with those flows (e.g., liquidity risk associated with deposits, credit risk associated with loans, market risk associated with fixed income securities, and interest-rate risk associated with the relative maturities of deposits, loans, and securities). However, commercial bank business models have evolved over the past two decades, and today banks generate an increased portion of their income from non intermediation and/or non interest activities. For example, between 1980 and 2001 non interest income in the U.S. commercial banking system increased from 0.77% to 2.39% of aggregate banking industry assets, and increased from 20.31% to 42.20% of aggregate banking industry operating income.


From Non interest Income and Financial Performance at U.S. Commercial Banks

The across-the-board growth of non interest income at commercial banks suggests that intermediation activities are becoming a less important part of banking business strategies. The data displayed in Figure 1 suggest otherwise. If intermediation activities have become less important for banks over time, it stands to reason that the correlation between bank profitability and bank net interest margin would grow weaker over time. Figure 1, which displays the average correlation of ROE and net interest margin each year between 1984 and 2001, shows no such weakening. Although these data are crude and exhibit substantial noise over time, they suggest an intriguing possibility: increased noninterest income is co-existing with, rather than replacing, intermediation activities at the typical commercial bank.

Technological and Financial Innovation:

From Non interest Income and Financial Performance at U.S. Commercial Banks

Advances in information and communications technology (e.g., the Internet, ATMs), new intermediation technologies (e.g., loan securitizations, credit scoring), and the introduction and expansion of financial instruments and markets (high-yield bonds, commercial paper, financial derivatives) all would have occurred in the absence of deregulation. But deregulation allowed banks to achieve the scale to use these new technologies more efficiently, and the increased competition induced by deregulation provided banks with the incentives to adopt and adapt these new technologies. Many of these new technologies have emphasized noninterest income while de-emphasizing interest income at banks. Banks can extract fee income from customers willing to pay a “convenience premium” for doing their banking at ATMs or over the Internet. Banks can earn loan origination, loan securitization, and loan servicing fees to offset the interest income that they lost with the disintermediation of consumer lending (e.g., mortages, credit cards). Banks can earn fees from selling back-up lines of credit to firms that float commercial paper rather than borrowing from banks.

Large Banks seems to have larger proportion of their income from Non Interest Income.  Smaller banks still depend on deposits and intermediation for source of their income.



Key data and Research/Analysis sources:


a) Bank’s Non-Interest Income to Total Income for United States


b) Banks Prime loan Rate


c) Banks’ Non-Interest Income and Systemic Risk

Markus K. Brunnermeier,a Gang Dong,b and Darius Paliab



d) How do banks make money? The fallacies of fee income

Robert DeYoung and Tara Rice

Click to access ep_4qtr2004_part3_DeYoung_Rice.pdf


e) Non-interest income and total income stability


Rosie Smith Christos Staikouras and Geoffrey Wood

Click to access wp198.pdf


f) What Does the Financial Crisis Teach Us

about Different Banking Models?

Volume 4, Number 3, Spring 2010

Click to access What_Does_the_Financial.pdf


g) Diversification in Banking
Is Noninterest Income the Answer?

Kevin J. Stiroh∗
September 23, 2002

Click to access sr154.pdf


h) Non interest Income and Financial Performance at U.S. Commercial Banks

Robert DeYoung Tara Rice


Click to access sr-2003-2-pdf.pdf


I) Banks Non-Interest Income and Global Financial Stability

Robert F. Engle

Fariborz Moshirian

Sidharth Sahgal

Bohui Zhang



J) Non-Interest Income Activities and Bank Lending

Pejman Abedifar, Philip Molyneux†c, Amine Tarazi

Click to access S10_P1_PejmanAbedifar.pdf


K) How do banks make money? A variety of business strategies

Click to access ep-4qtr2004-part4-deyoung-rice-pdf.pdf


L) How bank business models drive interest margins: Evidence from U.S. bank-level data

Saskia E. van Ewijk , Ivo J.M. Arnold

August 2012

Click to access 2-Van-Ewijk-How-bank-business-models-drive-interest-margins_aug2012.pdf


M) Banking in the United States

Robert DeYoung University of Kansas



N) Nontraditional Banking Activities and Bank Failures During the Financial Crisis

Gokhan Torna

Robert DeYoung


O) The Decline of Traditional Banking: Implications for Financial Stability and Regulatory Policy

Franklin R. Edwards and Frederic S. Mishkin


Click to access 9507edwa.pdf


P) The trade-off between bank fees and net interest margins.

By Barry Williams and Gulasekaran Rajaguru


Q) The chicken or the egg? The trade-off between bank fee income and net interest margins

Barry Williams Bond University, Gulasekaran Rajaguru


R) The Darkside of Diversification: The Case of U.S. Financial Holding Companies
Kevin J. Stiroh and Adrienne Rumble
November 2003

Click to access The%20dark%20side%20of%20diversification.pdf


S) The consolidation of the financial services industry: Causes, consequences, and implications for the future

Allen N. Berger Rebecca S. Demsetz , Philip E. Strahan


T) The Outlook for the U.S. Banking Industry: What Does the Experience of the 1980s and 1990s Tell Us?

Kenneth Spong and Richard J. Sullivan


U) Do Large Banks have Lower Costs?
New Estimates of Returns to Scale for U.S. Banks

David C. Wheelock and
Paul W. Wilson

Click to access 2009-054.pdf


V) The Geographic Distribution and Characteristics of U.S. Bank Failures, 2007-2010: Do Bank Failures Still Reflect Local Economic Conditions?

Craig P. Aubuchon and David C. Wheelock

Click to access Aubuchon.pdf


W) Banking Industry Consolidation and Market Structure: Impact of the Financial Crisis and Recession

David C. Wheelock

Click to access 419-438Wheelock.pdf


X) Consolidation and Merger Activity in the United States Banking Industry from 2000 through 2010

Robert M. Adams 2012

Click to access 201251pap.pdf



Bank Mergers and Banking Structure in the United States, 1980-98
By Stephen A. Rhoades



Y) Bank Mergers and Industrywide Structure, 1980–94

Stephen A. Rhoades


Click to access ss169.pdf


Z) Bank Merger Activity in the United States, 1994–2003

Steven J. Pilloff

Click to access ss176.pdf



AA) Consolidation in the U.S. Banking Industry: Is the “Long, Strange Trip” About to End?


Kenneth D. Jones and Tim Critchfield


Click to access article2.pdf


AB) The Transformation of the U.S. Banking Industry: What a Long, Strange Trip It’s Been

By: Allen N. Berger, Anil K. Kashyap and Joseph M. Scalise



AC) Consolidation in US Banking: Which Banks Engage in Mergers?

David C. Wheelock and
Paul W. Wilson

December 2002


Click to access 6608425.pdf


AD) Bank Consolidation: A Central Banker’s  Perspective

Fredric S. Mishkin


Click to access w5849.pdf


AE) The Transformation of the U.S. Financial Services Industry, 1975-2000: Competition, Consolidation and Increased Risks

Arthur E. Wilmarth Jr.,




Arthur E. Wilmarth, Jr.


Click to access wilmar.pdf


AG) How do changes in Market Interest rates affect Bank Profits?

Flannery, Mark J.

Business Review Sep (1980): 13-22.



AH) Bank profitability and the business cycle

by Ugo Albertazzi and Leonardo Gambacorta




Impact of Low Interest Rates on Bank’s Profitability

What is Impact of Low Interest rates on Banks’ profitability?

Fed reserve sets the monetary policy for improving employment and controlling inflation. Policy is implemented through setting up policy interest rates.

I point you to three charts below:

Effective Fed funds rate (EFFR). This rate, with high of more than 19 percent in 1981, is at 0.37 percent at present. In November 2008, the rate was at 0.39 percent and has remained low since then.  See reference (m).

Net Interest Margin of Banks has declined: Over the years, the NIM (Net Interest Margin) of banks, a measure of profitability, has eroded. Erosion continues. See the chart below reference (a).

Number of Banks in USA have declined: There were 14400 banks in 1984, 7175 in 2008, and now in 2016, there are only 5309 banks. Banks continue to fail/consolidate (M&A). See the chart below.  reference (b).


What does give rise to institutional cash pools and shadow banking, financial innovation (securitization), Bank failures, consolidation (M&A) and evolution of Too Big to Fail Banks, risk taking in lending and financial instability?  Rise in Debt, Credit and Capital Flows?

Too low interest rates for too long.


Here are some of the recent publications voicing their concerns:

2015 Annual Report of US Office of Financial Research (OFR) says:

OFR’s assessment of threats to the financial stability of the United States, discusses risk and resilience in the financial system.

The three chief threats are the: (1) impact of persistently low interest rates, (2) increasing debt and declining credit quality in U.S. corporations and emerging markets overseas, and (3) areas of weakness in the system that remain despite financial reforms and better risk management by financial companies. (page 5)

Long-term impact of low interest rates – Although some interest rates have recently moved higher, given the context just described, we expect the incentives for risk-taking from historically low interest rates to endure for some time.

Persistently low rates will continue to prompt investors to take higher risks to increase their returns on investment and may encourage excessive borrowing. (page 6)

At the media briefing of BIS Quarterly Review March 2016, On-the-record remarks by Mr Claudio Borio, Head of the Monetary and Economic Department, 4 March 2016.

But the main source of anxiety was the vision of a future with even lower interest rates, well beyond the horizon, that could cripple banks’ margins, profitability and resilience.


BIS views are shaped by the new research published in a paper. See reference (g).


Banks stocks are traded on wall street. The CEOS of banks are responsible to show revenue growth and earnings growth every quarter. How do they accomplish that in declining margins environment?

Risk taking, leverage, financial innovation, non-core business, industry consolidation, and aggressive accounting.


Fed policies to improve the real economy impact the banking/financial sector adversely.

I suggest that it was due to declining Interest rates in last thirty years that we had Global Financial Crisis.


Please take a look at latest data and research/analysis references below.

  1. Stijn Claessens, Nicholas Coleman, and Michael Donnelly, “‘Low-for-Long’ Interest Rates and Net Interest Margins of Banks in Advanced Foreign Economies,” Federal Reserve Board of Governors International Finance Discussion Papers Notes, April 11, 2016.
  2. Deutsche Bundesbank: Banks’ Net Interest Margin and the Level of Interest Rates; July 2015
  3. Atlanta Fed: Net Interest Margin Performance in a Low-Rate Environment 2012
  4. Richmond Fed: Do Net Interest Margins and Interest Rates Move Together? May 2016
  5. BIS: The influence of monetary policy on bank profitability October 2015
  6. FRB: Why are net interest margins of large banks so compressed ? October 2015
  7. Chicago Fed: What Is the Impact of a Low Interest Rate Environment on Bank Profitability? July 2014
  8. St.Louis Fed: Are Banks More Profitable When Interest Rates Are High or Low? May 2016
  9. Bank of England, UK: Simple banking: profitability and the yield curve June 2012


Key data and analysis sources:


a) Net Interest Margin for all U.S. Banks


b) Commercial Banks in the U.S.


c) Deutsche Bundesbank (German Central Bank): Banks’ Net Interest Margin and the Level of Interest Rates  July 2015


d) Stijn Claessens, Nicholas Coleman, and Michael Donnelly, “‘Low-for-Long’ Interest Rates and Net Interest Margins of Banks in Advanced Foreign Economies,” Federal Reserve Board of Governors International Finance Discussion Papers Notes, April 11, 2016.


e) Atlanta Fed: Net Interest Margin Performance in a Low-Rate Environment; Viewpoint Vol 25/4, 4th quarter, 2012


f) Richmond Fed: Do Net Interest Margins and Interest Rates Move Together?; Economic Brief No. 16-05, May 2016


g) BIS: The influence of monetary policy on bank profitability; October 2015

Click to access work514.pdf


h) OFR Annual Report 2015

Click to access office-of-financial-research-annual-report-2015.pdf


i) BIS Quarterly Review March 2016 – Media Briefing

Click to access r_qt1603_ontherecord.pdf


j) FRB: Why are net interest margins of large banks so compressed ?; Feds Notes October 2015


k) Chicago FedWhat Is the Impact of a Low Interest Rate Environment on Bank Profitability?; Chicago Fed Letters, No. 324, July 2014


l) St.Louis Fed: Are Banks More Profitable When Interest Rates Are High or Low?; On the Economy, May 16, 2016


m) Effective Fed Funds Rate


n) Bank of England, UK: Simple banking: profitability and the yield curve; Piergiorgio Alessandri and Benjamin Nelson; June 2012

Click to access wp452.pdf