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Should Banks Be Diversified? Evidence from Individual Bank Loan Portfolios

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  • Viral V. Acharya

    (London Business School and Centre for Economic Policy Research)

  • Iftekhar Hasan

    (Rensselaer Polytechnic Institute)

  • Anthony Saunders

    (New York University)

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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Bibliographic Info

Article provided by University of Chicago Press in its journal Journal of Business.

Volume (Year): 79 (2006)
Issue (Month): 3 (May)
Pages: 1355-1412

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Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:3:p:1355-1412

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