Bank Diversification and Overall Financial Strength: International Evidence

Abstract

There are many studies in the finance and management literature that examine the impact of diversification on performance. Yet, the literature remains inconclusive as for the potential benefits in terms of risk and return. The present study aims to re‐examine this issue, while proposing a methodological framework that integrates various bank performance and risk indicators into a single measure of financial strength. Using an international sample of commercial banks, we find that diversification in terms of income, earning assets, and on‐ and off‐balance sheet activities influences positively their financial strength. We also find that income diversification can be more beneficial for banks operating in less developed countries compared to banks in advanced and major advanced economies. However, we observe the opposite in the case of diversification between off‐balance sheet and on‐balance sheet activities. Furthermore, the results reveal that income and earning assets diversification can mitigate the adverse effect of the financial crisis on bank financial strength. We continue to find a positive relationship between diversification and financial strength when we account for nesting effects, endogeneity, as well as when using an alternative approach for the construction of the financial strength indicator.

The Impact of Revenue Diversification on Bank Profitability and Stability: Empirical Evidence from South Asian Countries

“…Applying system GMM methodology, they concluded that diversification across and within both interest and non-interest income-generating activities decreases insolvency risk (increases stability). Doumpos et al (2016) also found a positive relationship between diversification and financial strength (stability). So, in our first hypothesis we will also expect a positive relationship between revenue diversification and bank stability.…”

“…Consequently, the share of non-interest income has significantly increased for the banks of this region; banks on average earned about 32% of their operating income from non-interest income sources over the sample period of our study. Doumpos et al (2016), using a worldwide sample, concluded that revenue diversification is more beneficial for banks working in developing countries as compared to banks in developed countries. This fact warrants an intense investigation into the topic for South Asian banks which has been largely ignored in existing literature.…”

Do multinational banks create or destroy shareholder value? A cross‐country analysis

“…See a recent study from Doumpos et al. () who also enter income diversification when analyzing bank diversification.…”

Benefit From Income Diversification of Vietnamcommercial Banks

“…Consistent with Elsas et al (2010), Doumpos et al (2016) we use gross interest revenue so that the income diversitymeasure is not unduly distorted by the profitability of income related activities.The DIV index takes values between zero if the bank is fully specialized in a business area and 0.75 if the bank generates a mixture of incomes totallybalanced on the four sectors. Increasing DIV index shows that banks tend to the taller income diversification level to seek new income sources [15,16].…”

“…It takes values from −2.5 to 2.5, with higher scores corresponding to better outcomes. Most of them are standard control variables in the banking literature [16].…”