Income and Balance Sheet Diversification Effects on Banks’ Cost and Profit Efficiency: Evidence from the US

Abstract

Using two-stage instrumental variable technique and two-step system GMM approach, we provide empirical evidence on impact of income, asset, and funding diversifications on the cost and profit efficiency of the US commercial banks over the period from 2002 to 2019. Our results show that funding and income (assets) diversification has a positive (detrimental) effect on the cost efficiency of the banks, while funding (income) diversification has a significantly negative (positive) effect on profit efficiency. Our findings reveal that during the global financial crisis asset diversification is not beneficial for the banks, whereas funding ‎diversification has a positive effect on cost and profit efficiency.‎ Our results confirm bi-directional causality between cost and profit efficiency in commercial banks of the US. Out mixed results of the influence of income, asset, and funding diversifications on the cost and profit efficiency of the banks with varying characteristics have useful implications for policymakers and regulators‎.

Keywords: Cost efficiency; Profit efficiency; Diversification; Commercial banks

JEL Classification: G21, G28, G32