Income Diversification and Bank Performance: Evidence from Italian Banks

Using annual data from Italian banks, we study the link between non-interest revenues and profitability. We find that income diversification increases risk-adjusted returns. Our results provide econometric evidence consistent with current studies on EU banks, but do not support findings on the U.S. experience. In our view, the differences depend primarily on the relative importance of local banks: we find that the relation is stronger at large banks. In addition, we find that there are limits to diversification gains as banks get larger. Small banks can make gains from increasing non-interest income, but only when they have very little non-interest income share to start with. The source of non-interest income is less important than its level.