Should Banks be Diversified? Evidence from Individual Bank Loan Portfolios

61 Pages Posted: 13 Dec 2005  

Viral V. Acharya

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

Anthony Saunders

New York University - Leonard N. Stern School of Business

Iftekhar Hasan

Gabelli School of Business, Fordham University; Bank of Finland

Multiple version iconThere are 2 versions of this paper

Date Written: September 2002

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. Our most important findings are 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 produces an inefficient risk-return tradeoff only for high risk banks, and geographical diversification results in an improvement in the risk-return tradeoff for banks with low levels of risk. A robust result that emerges from our empirical findings is that diversification of bank assets is not guaranteed to produce superior performance and/or greater safety for banks.

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

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

JEL Classification: G21, G28, G31, G32

Suggested Citation

Acharya, Viral V. and Saunders, Anthony and Hasan, Iftekhar, Should Banks be Diversified? Evidence from Individual Bank Loan Portfolios (September 2002). BIS Working Paper No. 118; AFA 2003 Washington, DC Meetings; London Business School; NYU Stern School of Business Working Paper. Available at SSRN: https://ssrn.com/abstract=293295 or http://dx.doi.org/10.2139/ssrn.293295

Viral V. Acharya (Contact Author)

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

44 West 4th Street
New York, NY NY 10012
United States

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

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

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

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)

Iftekhar Hasan

Gabelli School of Business, Fordham University ( email )

Rose Hill Campus Bronx
New York, NY 10458
United States

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

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