The trade off between interest income and non interest income of vietnam commercial banks

Datadescription Ourresearchusesdataof27commercialbanksinVietnamfrom2006-2015.Foreignbank,foreignbankbranches,joint- venturebanksaren’tincludedinthesamplebecausedataofthesebanksaren’tupda

HOANGHAIYENUniversityo f E c o n o m i c s H C M C – y e n h h @ u e h e d u v n

1 Introduction

Themaintraditionalactivitiesofbanksincludedeposittakingandlending.Besidest h e s e activities,banksalsodiversifytheiractivitiestonon-

interestincomeactivitiesandt h i s trendbecomemoreandmorepopular.ResearchofStiroh(2004)onAmericanbankssta te dthatin1980snon-interestincomeactivitiesaccountfor19%totalbanks’incomew h i l e2001thisnumberwas43%.StudiesofLepetit,Nys,Rous,andTarazi(2008)onEuropeanbanksalsogotthesameresults,thepercentageofnon-

interestincomei n c r e a s e d f r o m 2 6 % t o 4 1 % T h i s t r e n d i s a l s

o r e p e a t e d i n o t h e r c o u n t r i e s s u c h a s Australia,ChinaalthoughthegrowthrateisnotashighasinUSandEurope.Thestrongincreasinginnon-interestincomeraisesaquestion

forbankmanagersandresearchers:whetherincreasinginnon-interestincomeactivitiesisgood forbanks?

Shouldbanks c o n t i n u e thistrend?

Manyresearchesrelatedtothisfieldareconductedbutresultsarem i x findings

Vietnama l s o f o l l o w s thist r e n d W i t h difficultiesi n c r e d i t

e x p a n s i o n , banksa r e i nc r ea s i ng l y interestincomeactivities.Resultsofthisshiftaren o t fully assessed.Priorresearchesi n Vi e t na m o n l y s t ud ie da bo ut th e s ol e i m p a c to f diversify income(interestincomeandnon-

seekingrevenuesfromnon-interestincome)toprofitortoriskbuttheseresearches haven’tassesseds y s t e m a t i c a l l y t h e trade-

offbetweenriskandreturnofi n t e r e s t interestincome activities Thatthereasonwhywe studyabout“thetrade-offbetweeninterestincomeandnon-

incomeactivitiesandnon-interestincomeofVietnamc o m m e r c i a l banks”

Non-interestincomeinclude“fiduciaryincome,servicecharges,tradingrevenue,andfeesa n d o t h e r income”(Stiroh,2 0 0 4 ) I n ourresearch,w e use“TotalNon-interestO p e r a t i n g Income” in the balance sheetof

offbetweenriskandreturn(ViandR APasWilliamsandPrather(2010).Datafrom27Vietnamcommercialbanksbetween2006and2015iscollectedfromBankscope.Wefindthatdiversificationactivitiestonon-interestincomeincreasesreturnagainstoneunitofrisk.However,thisreturnwillreduceifwecontinuetoshifttonon-

Toexploittheproblems,weusetworatiostomeasurethetrade-interestincomeactivities.Thisresultencouragesbankstoi n v e s t innon-

interestincomeactivitiesbuttheyalsoneedtocontroltheseactivitiestoavoidover-investment

Ourpaperis

constructedintofiveparts.Thenextpartwillbeliteraturereviewabouti n

c o m e diversification.Thethirdpartdescribesdataandmethodology.Thefourthpartdiscussestheresultsandfinalpartisconclusions

o sufferhigherrisks.However,allth e r e s e a r c h e s agreedatthesamepointthattraditionalactivitiesarelessriskthan noninterestactivities

DeYoungandRoland(2001)examineson472UScommercialbanksbetween1988and1995.Theytriedtoanswerwhether,howandtowhatdegreetheshiftstononinterestincomeaffectthevolatilityofbankearnings.Resultsreveal thatshiftingfromtraditionalactivitiestonon-traditionalactivitieswasincreasingandbank’sreturnincreasedwhent h e y diversifytononinterestincomeactivities.However,thevolatilityofbankearningswasalsohigher.Stiroh(2004)hadthesamepointofviewwithDeYoungandRoland(2 00 1 ) t h a t non-

interesti n c o m e w a s m o r e v o l a t i l e t h a n t r a d i t i o n a l income.A u t h o r s t u d i e d USbanksfromthelate1970sto2001toexaminetheaffectionsofnon-

interestin co me tobanksprofitandrevenue.Hefoundthattherewasareductioninvolatilityofb a nk revenuegrowthin 1990sbutthiswasbecauseofthelowervolatilityofnetinteresti n co m e “ r a t h e r t h a n t h

e d i v e r s i fi c a t i o n b e n e fi t s f r o m i n c r e a s e d n o n i n t e r e s t i

n c o m e ” (Stiroh,2004).He concludedthatnoninterestincomewasstillmorevolatilethannet

2013.Theyconcludedthatbanksincreasingf e e

-b a s e d activitiesmaygetlowerprofitsandhigherrisksthan-bankspursuingtraditionalactivities

Incontrastwiththeaboveresearches,thefollowingstudiesconfirmedthat shifttononinteresti n c o m e a c t i v i t i e s b r i n g b e

n e fi t s t o b a n k s S m i t h , S t a i k o u r a s , a n d W o o d (2003)studiedt h e variabilityandt h e correlationbetweeninterestandnon-interesti n c o m e forba nks inE urope a n c ou nt ri e s from 1994-1998.Sa m ple in c l ud e d 200la rge b a nk s havingtotalassetsover10billionsUSDand2455smallbanks.Theresearchfoundthat shifttonon-interestincomemakeprofitsinEuropeanbanksstableintheresearchperiod.Inaddition,recentstudyofLee,Yang,andChang(2014)for967banksof22Asiac o u n t r i e s from1995to2009abouttheimpactsofnon-interestincomeonprofitsand risks foundthatnon-

interestincomereducedrisksbutdidnotincreaseprofit.Especially,r e s u l

t s becamecomplicatedwhenbankspecializationandacountry'sincomelevelwereconsidered.Tosavingbanks,profitreducedandrisksincreasedwhentheyshifttonon-i n t e r e s t

i n c o m e activities.Inhighincomecountries,theseactivitiesincreasedbankriskswhileinmiddleandlowincomecountries,non-

interestincomeactivitiesincreasedprofitsanddecreasedrisks

basedincomeactivitiestoreturnsandrisksbuttheyaccessedthetrade-offbetweenreturnsandrisks.R e s u l t s fromtheseresearchesarealsomixfindings.Someempiricalresearchesfindfee-

Otherresearchesdidnotexaminesoleimpactsofshiftingtofee-

basedincomeactivitieshavenegativeimpactstothetrade-offbetweenreturnsandriskswhileotherstudiesgetoppositeresults.DeYoungandRice(2004)provedthatincreasingn o n i n t e r e s t incomeactivitiesleadtohighervolatilitiesinreturns.Theyresearched4,712commercialbanks in United State from 1989 to 2001 with 37,175

-i n t e r e s t -i n c o m e , b u s -i n e s s s t r a t e g -i e s , m a r k e t c o n d -i t -i o

n s , technological changesandfinancialperformance Theresultsstatedthatincreasinginnon-interestincomemadethetrade-offbetweenrisksandreturnspoorer.Inaddition,s t u d y ofStirohandRumble(2006)forFinancialHoldingCompanies–FHCsinUnited

Statealsogotthesameresults.Theyresearched1800FHCsfrom1997to2002andfoundevidences aboutthebenefitsofdiversification.However,thesebenefitswereoffsetbyi n c r e a s i n g companies’investmentsinnon-

offbetweenrisksandreturnswhenbanksshiftfromtraditionalactivitiestofee-

basedincomeactivities.WilliamsandPrather(2010)researchedon49commercialbankswhichincluded4bigbanksaccountedfor 65%totalassetsofcommercialbanksinAustraliaandissuedmostoffinancialproducts,thesecondgroupwasdomesticbanksspecializedinretailfinanceand thethirdgroupwasforeignbanks.Theyconcludedt h a t non-traditionala c t i v i t i e s werer i s k i e r t h a n traditionalactivities.However,combiningthesetwoactivitieswasbenefitforshareholdersindiversificationtheirportfolioandreducedrisksforbanks

3 Datadescriptionandmethodologies

3.1 Datadescription

Ourresearchusesdataof27commercialbanksinVietnamfrom2006-2015.Foreignbank,foreignbankbranches,joint-

venturebanksaren’tincludedinthesamplebecausedataofthesebanksaren’tupdatedinBankscope.AsstatisticofStateBankofVietnam,thereare33commercialbanks.Thisresearchexcludes6commercialbanks:GlobalPetroBank,NationalCitizenBank,BacABank,KienLongBank,HDBankandVietbankbecausedataofthesebanksaren’tupdatedin5yearsconsecutivefrom2006-2015

Whenstudyingthed i ff e r e n c e s b e t w e e n

state-ownedb a n k s a n d o t h e r j o i n t stockc o m m e r c i a l banks,weusetheclassificationofStateBankofVietnam.However,groupofstate-

ownedbanksjustincludes4banks:BankforForeignTradeofVietnam,BankforInvestmenta n d D e v e l o p m e n t o f V i e t n a m , V i e

t n a m B a n k f o r A g r i c u l t u r e a n d R u r a l Development,VietnamJoint-

ownedbanks we re a c quire dbySta te Ba nkofV ie tna m duringthe re s truc turing

3.2 Methodologies

Weusetwoindexestomeasurethetrade-offbetweenrisksandreturnsinresearchofW i l l i a m s andPrather(2010)

First,descriptives t a t i s t i c isconductedt o c o m p a r e

non-interesti n c o m e a n d n e t i n t e r e s t incomeforallbanksinthesampleandin2groupsofbanks(state-

ownedbanksandothe r jo in ts to c kc om m e rc i a l ba nk s ) R e s ul ts

f ro m d e s c r ip ti ve s t a t is ti c r e v e a lt he stableoftheseincomesourcesandwhichsourceisthemainincomesourceofbanks.Aftert h a t , thepercentageofeachincomesourceiscalculatedtoknowthetrendofshiftingtonon-interestincomeactivitiesinVietnambankingsystem

Second,ino r d e r t o understandw h e t h e r diversificationi n t o non-

interesti n c o m e activitiesisbenefitforbanks,theauthorsundertakethreesteps

Calculatecorrelationoffiveelements:netinterestincomeagainsttotalassets,non-

interes tincomeagainsttotalassets,netinterestincomeagainsttotalequity,non-interestincomeagainsttotal equityand ROEbefore

combinationofbothtraditionalandnon-traditionalactivitiescanreducebankrisksornot.Besides,r e s u l t salsostateifnon-interestincomeactivitiesisbenefitforshareholders.CalculateVi(Williams&Prather,2010).Thisindexstatehowmuchriskbankshavet o tradeoffforoneunitofreturn

бiistheannualstandarddeviationofreturnsforincomesourcei

µiistheaverageannualreturnfortheincomesourcei

CalculateRAP(Williams&Prather,2010)whichisthereturnpremiumforeachunitofrisk.ComparisonRAPofnetinterestincome,RAPofnon-

interestincomeandRAPoft o t a l incomewillgivetheconclusionwhethershifttonon-interestincomebringbenefitf o r banksornot

interesti n

Non-c o m e /

T o t a l a s

s e t s

Netinterestinco me /Totalassets

Interestincome /Totalincome

Meanso f n e t i n t e r e s t i n c o m e aren’tdifferentf o r banksint w o groups.However,s t a n d a r d deviationofnetinterestincomeforstateownedbanksissmallerthanthatvalueforotherjointstockcommercialbanks.Aboutnon-interestincomeagainsttotalassets,mea n of sta te -owned banks is higherthan thevalueof joint stock commercial

butthevolatilityofnon-interestincomeagainsttotalassetsforsecondgroupofbanksismuchhigherthanthefirstgroup.Theresultsfromtable1alsostatetraditionalactivitiesarem a i n sourceofincomeforbankswiththeproportionofinterestincomeintotalincomeisabove90%

Duringthe80s,non-interestincomesinUnitedStateaccountedfor19%totalincomewhilein2001thisratewas43%

(Stiroh,2004).ThesametrendalsohappenedinEuropewith

increasing from26%in1989to41%in1998(ECB2000).InVietnam,shifttonon-

interestincomeactivities isnotasstrengthastheaboveregions.Statisticinresearchp e r i o d from2006-2015,thepercentageofnon-interestincomeonlyaccountsfor8%oft o t a l incomeandthisproportionhasbeenreducingsince2010untilnow.Before2011,thep e r c e n t a g e ofnon-interestincomewasabout11%oftotalincomebutin2011-

2015,itwaso n l y

5-6%.Thesenumberstatethattherewasastrongreducing intheproportionofnon-

interestincome.Wedon’tinvestigatethereasonsofthisreducing.However,thetimestartingforthedowntrendwasthesamewiththetimetheStateBankofVietnamstartedtorestructurethebankingsystems.Therefore,wequestionwhethertherestructuringb a nk i ng systemshadimpactstotheproportionofnon-

interestincome.Fromtheaboveanalysis,wedividetheresearchperiodintotwoparts:firstperiodisfrom2006to2010a n d thesecondperiodisfrom2011-2015

Figure1:Theproportionofinterestincomeandnon-interestincomeovertotalincome

of non- interest income against total income

The proportion of non- interest…

3.50%

3.00%

2.50%

interest income against total assets 2.00%

interestincome.Theresultss t a t e thatthecorrelationofthesetwosourcesofincomeforthegroupofallbanksorforthegroupo f j o i n s t o c k c o m

m e r c i a l b a n k s a r e n e g a t i v e T h e s e r e s u l t s c o n fi r m t h

a t

combininginterestincomeactivitiesandnon-interestincomeactivitiescanreducetotalriskforbanks.Inaddition,thecorrelationsbetweenpre-taxROEandnon-

interestincomeagainstequitiesforthesetwogroupsofbanksarepositive.Itmeansthatincreasenon-

interestincomeagainstt o t a l equityandnetinterestincomeagainsttotalassetsis+0.04 Therefore,fromtheaboveinform a tion, i t’ s ha rd t oc on c l ud e whethert he c om bina tion o fi nt e r e s tinc om e activitiesandnon-

interestincomeactivitiesisgoodornotforstate-ownedbanks

Table2

Correlationofelements

Netinter esti n c o

m e /

t o t a l as

interest

Non-i n c o m

e /

t o t a l as sets

Netinter esti n c o

m e /

t o t a l eq

interest

Non-i n c o m

e /

t o t a l e quity

Pretax ROE

PretaxROE 0.19 0.4

0

0.3 6

STATE-OWNEDBANKS

Netinter esti n c o

m e /

t o t a l as

interest

Non-i n c o m

e /

t o t a l as sets

Netinter esti n c o

m e /

t o t a l eq

interest

Non-i n c o m

e /

t o t a l e quity

Pretax ROE Netinterestincome/

incomeandnon-income/total equity ALLBANKS

basedi n c o m e i s m u c h r i s k i e r t h a n t r a d i t i o n a l incomes.Thisresultisconsistentwithresearchesinthe literaturerevie w W h e nwecomparetwogroups:state-

ownedbanksandjointstockcommercialbanks,Viindexesofstate-ownedbanksgrouparemuchsmallerthantheseindexesinjointstockcommercial banksgroup andthedifferencesbetweenViof intere

st incomeandnon- i n t e r e s t

incomeofstate-ownedbanksgrouparealsosmallerthanthedifferencesofjointstockcommercialbanksgroup.Thisconfirmsthatstate-

ownedbankssufferlessriskthanjo int stockcommercialbanks

Althoughrisksfromnon-interestincomeactivitiesaremuchhigherthanrisksfromtraditionalactivities,Vioftotalnetinterestincomeandnon-interestincome/

totalequityi s smallerthannetinterestincome/

totalequity.Thisresultstatesthatshiftingtofee-basedincomewillreduceriskswhichshareholdershavetosuffer

Considerrisksandreturnstradeoffatanotherangle,weuseRAPiwhichisanindexm e a s u r i n g excessreturnperunitofrisk.ResultsofRAPiofeachbankgrouparepresentedi n thefollowingtable

Non-i n c o m e

Totalnetinterestincome andnon-interestincome PretaxROE

Non-ar

inco

me

inco me

733

Non-i n c o m e

Totalnetinterestincome andnon-interestincome PretaxROE

Duringtheresearchperiod,RAPoftotalnetinterestincomeandnon-ownedbanksgroup).Theseresultsprovet h a t whendiversificationtonon-

interestincomeactivities,returnperunitofriskwillbeh i g h e r thanreturnperunitofriskifbanksjustinvestininterestincomeactivities.RAPinthewholeresearchperiod2006-2015orRAPineachperiod2006-

2010and2011-2015forallbanksorforeachgroupofbanksalsogetthesameresult.Thisonemoretimeconfirmst h a t t h e c o m b i n a t i o n o f non-interesti n c o m e a c t i v i t i e s a n d i n t e r e s t i n c o m e

732 |

ICUEH2017

activitiesgetshigherreturnperunitofriskthanjustinvestinginnetinterestincome.Therefore,shiftingtofee-basedincomeisreasonable.Theaboveresultsalsorevealthatatacertaintime,RAPof non-

interestincomeisnegative.Atthattime,althoughRAPoftotalnetinterestincomeandnon-interestincomeishigherRAP

ofn e t i n t e r e s t

income,insteadofinvestinginnon-interesti n c o m e , investinginriskfreerateswillproducebetterreturn.Anotheri s s u e w e fi n d f r o m t h e a b o v e r e s u l t i s t h a t d u r i n g

2 0 0 6 - 2 0 1 0 w h e n

theproportionofnon-interestincomeisabout11%oftotalincome,RAPofallbanksandRAPo f j o i n

t s t o c k c o m m e r c i a l b a n k s a r e l o w e r t h a n t h e s e v a l u e s i n 2

0 1 1 - 2 0 1 5 w h e n t h e 6%oftotalincome.T h i s resultrevealst h a t althoughdiversificationtonon-

proportionofnon-interestincomeisonlyabout5-interestincomeactivitiesincreasesreturnperunitofr i s k , t h e m o r e i n v

e s t s i n

non-interesti n c o m e a c t i v i t i e s , t h e l e s s b e n e fi t d e r i v e f r o m diversificationbecausereturnperunitofriskwillreduce

5 Conclusions

UsingViandRAPi,wefindthatalthoughriskstoshareholdersreducewhenbanksdiversificationtonon-

interestincomeactivities,returnsfromthesenon-traditionalactivitiesareriskierthanreturnsfromtraditionalactivities.Besides,whenbanksdiversifyt h e i r activities,returnperunitofriskincrease.However,themoreinvestsinfee-

basedi n c o m e activities,thelessbenefitderivefromdiversificationbecausereturnperunitofriskwill re duce Insumma ry,diversification tonon-

interestincome activities isrightt ra ck butincreasingtheproportionofnon-

interestincomeactivities,returnperunitofr i s k willdecrease.Therefore,bankmanagersshouldcontroltheirshiftingtonon-

interestin co me activitiestoexploitthebenefitofdiversificationandavoiddisadvantages

Testingthedifferenceofriskandreturntrade-

offbetweentwobankgroups(state-o w n e d banksandjoffbetweentwobankgroups(state-ointstoffbetweentwobankgroups(state-ockcoffbetweentwobankgroups(state-ommercialbanks)wefindthatthereisadifferenceinrisksufferedbytwogroups.Riskperunitofreturnofstate-ownedbanksismuchsmallert h a n thisvalueofotherjointstockcommercialbanks