BOFIT Discussion Papers, Institute for Economies in Transition, Bank of Finland
No 9/2010:
Does diversification increase or decrease bank risk and performance? Evidence on diversification and the risk-return tradeoff in banking
Allen N. Berger ()
, Iftekhar Hasan, Iikka Korhonen ()
and Mingming Zhou
Abstract: Conventional wisdom in banking argues that diversification
tends to reduce bank risk and improve performance, but the recent financial
crisis suggests that aggressive diversification strategies may have
resulted in increased risk taking and poor performance. This paper
addresses this important question by evaluating the empirical relationship
between diversification strategies and the risk-return tradeoff in banking.
Our data set covers Russian banks during the 1999-2006 period and finds
somewhat mixed results. Specifically, we find that banks’ performance tends
to be non-monotonically related to their diversification strategy. The
marginal effects of focus indices (inverse measures of diversification) on
performance are nonlinearly associated with the level of risk and foreign
ownership. A focused strategy is found to be associated with increased
profit and decreased risk only up to a certain threshold. Additionally,
when foreign ownership is either very high or very low, banks tend to
benefit more from being diversified. This analysis provides important
strategic and policy implications for bank managers and regulators in
Russia as well as in other emerging economies.
Keywords: banks; diversification; focus; Russia; foreign ownership; scope economies; (follow links to similar papers)
JEL-Codes: G21; G28; G34; (follow links to similar papers)
56 pages, June 21, 2010
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