Does diversification increase or decrease bank risk and performance? : Evidence on diversification and the risk-return tradeoff in banking

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Title: Does diversification increase or decrease bank risk and performance? : Evidence on diversification and the risk-return tradeoff in banking
Author: Berger, Allen N. ; Hasan, Iftekhar ; Korhonen, Iikka ; Zhou, Mingming
Organization: Bank of Finland
Department / Unit: Institute for Economies in Transition (BOFIT)
Series: BOFIT Discussion Papers
Series number: 9/2010
Year of publication: 2010
Publication date: 18.7.2010
Pages: 56 s.
Keywords: pankkitoiminta; riskit; tuotot; ulkomaiset pankit; hajautus; Venäjä; kannattavuus; Bofit-kokoelma
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.
Rights: https://helda.helsinki.fi/bof/copyright


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