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

Anthony Saunders, Viral Acharya and Iftekhar Hasan

No 3252, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We study empirically the effect of focus (specialization) versus diversification on the return and the risk of banks using data from 105 Italian banks over the period 1993?99. Specifically, we analyse the trade-offs 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 produces an inefficient risk?return trade-off only for high-risk banks. Geographical diversification on the other hand does result in an improvement in the risk?return trade-off 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.

Keywords: Focus; Diversification; Monitoring; Bank risk; Bank return (search for similar items in EconPapers)
JEL-codes: G21 G28 G31 G32 (search for similar items in EconPapers)
Date: 2002-03
New Economics Papers: this item is included in nep-cfn, nep-geo and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (35)

Downloads: (external link)
https://cepr.org/publications/DP3252 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Working Paper: The effects of focus and diversification on bank risk and return: evidence from individual bank loan portfolios (2002)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:3252

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP3252

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().