Does diversification promote systemic risk?

We measure systemic risk when faced with simulated shocks through the systemic model of banking originated losses. The formation mechanism of systemic risk is explored from the perspective of investment diversification and asset similarity. The results indicate that contagion risks formed by the over similarity of investment assets are the main cause of systemic risk. The similarity generally promotes contagion risks, however, it shows a double-faced effect for state-owned commercial banks that disperse shocks from counterparties through their too-big-to-fail advantages. The similarity is determined by diversification, which initially promotes similarity and disperses it after a threshold. The diversification acts on the contagion process of systemic risk by the mediation of the similarity. Therefore, diversification generally has a nonlinear impact on systemic risk. The results provide regulatory implications for the systemic stability of the banking system.