Modelling and measuring business risk and the resiliency of retail banks

The paper uses recent developments of the methodology of efficiency frontiers to provide an original modeling of the risk of volatility of banking profits which relies on the estimation of a profit frontier. This methodology allows taking into account coordinated adjustments of banks’ costs to revenues as well as the absence of such adjustments. The study uses data of more than ninety French institutions running a retail banking business model over the period 1993 to 2012. Results confirm the resiliency of retail banks in crisis period. The decrease in profitability seems largely sustainable even if case of severe shocks. Thus, in case of a large drop in the banks’ lending activity, profit decreases moderately if costs are adjusted quickly, more largely if they are not. A shock on the provision of liquidity services shows less significant effects. In case where banks cannot adjust operating costs, only a very strong shock precipitating banks in the situation of the 5% less profitable could destroy completely yearly profits.