Diversification, Efficiency and Risk of Banks: Evidence From Emerging Economies

Abstract

This paper examines the impact of business diversification of banks on their risk, with efficiency taken into consideration as a conduit. Using bank-level data from more than 1000 commercial banks in 39 emerging economies during the period of 2000-2016, we find that increased business diversification exerts two competing effects on bank risk. The direct effect of increased diversification bolsters the stability of banks, but it is offset by the indirect effect whereby lowered efficiency, which is resulted from higher diversification, increases the riskiness of banks. In addition, we also find some evidence that the diversification-risk nexus is heterogeneous on the size, market power and ownership of banks.

Keywords: Diversification; efficiency; bank risk; emerging economies

JEL Classification: G21; G15; L25