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Assessing the Profitability and Riskiness of Small Business Lenders in the Banking Industry

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Author Info

  • James W. Kolari

    (Texas A&M University)

  • Charles C. Ou

    (Office of Economic Research, Office of Advocacy, U.S. Small Business Administration)

  • G. Hwan Shin

    (University of Texas at Tyler)

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    Abstract

    Two alternatives research hypotheses concerning how small business lending affects bank profitability are tested. The specialization hypothesis argues for higher profitability than other banks due to increased focus on small business lending, whereas the diversification hypothesis asserts that small business lenders' profitability will be lower than other more diversified banks. Using the rate of return on assets as the profit measure, we find that small business exposure tends to have neutral or positive effects on bank profitability after taking into account bank risk. Using efficient frontier analyses that focus on the rate of return on equity, we find that business lenders reap benefits from specialization, particularly in terms of reducing failure risk. We conclude that the evidence supports the specialization hypothesis.

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    Bibliographic Info

    Article provided by Pepperdine University, Graziadio School of Business and Management in its journal Journal of Entrepreneurial Finance and Business Ventures.

    Volume (Year): 11 (2006)
    Issue (Month): 2 (Summer)
    Pages: 1-26

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    Handle: RePEc:pep:journl:v:11:y:2006:i:2:p:1-26

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    Web page: http://bschool.pepperdine.edu/jef
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    Related research

    Keywords: Bank; Banking; Risk; Lending; Small Business;

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    References

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    1. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," The Journal of Business, University of Chicago Press, vol. 68(3), pages 351-81, July.
    2. Yakov Amihud & Baruch Lev, 1981. "Risk Reduction as a Managerial Motive for Conglomerate Mergers," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 605-617, Autumn.
    3. Berger, Allen N. & Saunders, Anthony & Scalise, Joseph M. & Udell, Gregory F., 1998. "The effects of bank mergers and acquisitions on small business lending," Journal of Financial Economics, Elsevier, vol. 50(2), pages 187-229, November.
    4. Lang, Larry H P & Stulz, Rene M, 1994. "Tobin's q, Corporate Diversification, and Firm Performance," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1248-80, December.
    5. Charles P. Himmelberg & R. Glenn Hubbard & Darius Palia, 2000. "Understanding the Determinants of Managerial Ownership and the Link Between Ownership and Performance," NBER Working Papers 7209, National Bureau of Economic Research, Inc.
    6. Fama, Eugene F., 1985. "What's different about banks?," Journal of Monetary Economics, Elsevier, vol. 15(1), pages 29-39, January.
    7. Steven A. Sharpe, 1989. "Asymmetric information, bank lending, and implicit contracts: a stylized model of customer relationships," Finance and Economics Discussion Series 70, Board of Governors of the Federal Reserve System (U.S.).
    8. Joseph G. Haubrich, 1998. "Bank diversification: laws and fallacies of large numbers," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 2-9.
    9. David P. Ely & Kenneth J. Robinson, 2001. "Consolidation, technology, and the changing structure of banks' small business lending," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q I, pages 23-32.
    10. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
    11. Katherine A. Samolyk, 1994. "U.S. banking sector trends: assessing disparities in industry performance," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 2-17.
    12. Saunders, Anthony & Strock, Elizabeth & Travlos, Nickolaos G, 1990. " Ownership Structure, Deregulation, and Bank Risk Taking," Journal of Finance, American Finance Association, vol. 45(2), pages 643-54, June.
    13. Fama, Eugene F., 1980. "Banking in the theory of finance," Journal of Monetary Economics, Elsevier, vol. 6(1), pages 39-57, January.
    14. Denis, David J & Denis, Diane K & Sarin, Atulya, 1997. " Agency Problems, Equity Ownership, and Corporate Diversification," Journal of Finance, American Finance Association, vol. 52(1), pages 135-60, March.
    15. Winton, Andrew, 1997. "Competition among Financial Intermediaries When Diversification Matters," Journal of Financial Intermediation, Elsevier, vol. 6(4), pages 307-346, October.
    16. Ralph C. Kimball, 1997. "Specialization, risk, and capital in banking," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 51-73.
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    Cited by:
    1. Goddard, John & McKillop, Donal & Wilson, John O.S., 2008. "The diversification and financial performance of US credit unions," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1836-1849, September.

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