The Effects of Focus and Diversification on Bank Risk and Return: Evidence from Individual Bank Loan Portfolios

25 Pages Posted: 3 Nov 2008

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Iftekhar Hasan

Fordham University ; Bank of Finland; University of Sydney

Anthony Saunders

New York University - Leonard N. Stern School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: December 2001

Abstract

We study empirically the effect of focus (specialization) vs. diversification on the return and the risk of banks using data from 105 Italian banks over the period 1993 1999. Specifically, we analyze the tradeoffs between (loan portfolio) focus and diversification using a unique data set that is able to identify individual bank loan exposures to different industries, to different sectors, and to different geographical regions. Our results are consistent with a theory that predicts a deterioration in bank monitoring quality at high levels of risk and a deterioration in bank monitoring quality upon lending expansion into newer or competitive industries. We find that industrial loan diversification reduces bank return while endogenously producing riskier loans for all banks in our sample, this effect being most powerful for high risk banks. Sectoral loan diversification only produces an inefficient risk return tradeoff for banks with very high levels of risk. Geographical diversification on the other hand does result in an improvement in the risk return tradeoff for banks with low levels of risk. Overall, our results suggest that diversification of bank assets is not guaranteed to produce more performance efficient and/or safer banks.

Keywords: Banking, Focus, Diversification, Monitoring, Bank risk, Bank return

Suggested Citation

Acharya, Viral V. and Hasan, Iftekhar and Saunders, Anthony, The Effects of Focus and Diversification on Bank Risk and Return: Evidence from Individual Bank Loan Portfolios (December 2001). NYU Working Paper No. FIN-01-060, Available at SSRN: https://ssrn.com/abstract=1294605

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR)

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European Corporate Governance Institute (ECGI) ( email )

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National Bureau of Economic Research (NBER)

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Iftekhar Hasan

Fordham University ( email )

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Bank of Finland ( email )

P.O. Box 160
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Finland

University of Sydney ( email )

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Australia

Anthony Saunders

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
9-190, MEC
New York, NY 10012-1126
United States
212-998-0711 (Phone)
212-995-4220 (Fax)

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