Should Banks Be Diversified? Evidence from Individual Bank Loan Portfolios*

2006/04/10 by Viral V. Acharya, Viral V. Acharya, Iftekhar Hasan +1 · 5 citations
Economics, Econometrics and Finance · Business, Management and Accounting · #Banking stability, regulation, efficiency #Corporate Finance and Governance #Italy: Economic History and Contemporary Issues

paper · doi:10.1086/500679

Abstract

We study the effect of loan portfolio focus versus diversification on the return and the risk of 105 Italian banks over the period 1993–99 using data on bank-by-bank exposures to different industries and sectors. We find that diversification is not guaranteed to produce superior performance and/or greater safety for banks. For high-risk banks, diversification reduces bank return while producing riskier loans. For low-risk banks, diversification produces either an inefficient risk-return trade-off or only a marginal improvement. Our results are consistent with a deterioration in the effectiveness of bank monitoring at high risk-levels and upon lending expansion into newer or competitive industries.

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