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Does diversification improve the performance of German banks? : Evidence from individual bank loan portfolios

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Author Info
von Westernhagen, Natalja
Porath, Daniel
Hayden, Evelyn

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Abstract

Should banks be diversified or focused? Does diversification indeed lead to enhanced performance and, therefore, greater safety for banks, as traditional portfolio and banking theory would suggest? This paper investigates the link between banks? profitability (ROA) and their portfolio diversification across different industries, broader economic sectors and geographical regions measured by the Herfindahl Index. To explore this issue, we use a unique data set of the individual bank loan portfolios of 983 German banks for the period from 1996 to 2002. The overall evidence we provide shows that there are no large performance benefits associated with diversification since each type of diversification tends to reduce the banks? returns. Moreover, we find that the impact of diversification depends strongly on the risk level. However, it is only for moderate risk levels and in the case of industrial diversification that diversification significantly improves the banks? returns. --

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Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2006,05.

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Date of creation: 2006
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Handle: RePEc:zbw:bubdp2:4536

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Related research
Keywords: focus; diversification; monitoring; bank returns; bank risk;

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Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. von Kalckreuth, Ulf, 2005. "A "wreckers theory" of financial distress," Discussion Paper Series 1: Economic Studies 2005,40, Deutsche Bundesbank, Research Centre. [Downloadable!]
  2. Slacalek, Jirka & Fritsche, Ulrich & Dovern, Jonas & Döpke, Jörg, 2005. "European inflation expectations dynamics," Discussion Paper Series 1: Economic Studies 2005,37, Deutsche Bundesbank, Research Centre. [Downloadable!]
  3. Campbell, John Y. & Hilscher, Jens & Szilagyi, Jan, 2005. "In search of distress risk," Discussion Paper Series 1: Economic Studies 2005,27, Deutsche Bundesbank, Research Centre. [Downloadable!]
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  4. Koetter, Michael & Bos, Jaap W. B. & Heid, Frank & Kool, Clemens J. M. & Kolari, James W. & Porath, Daniel, 2005. "Accounting for distress in bank mergers," Discussion Paper Series 2: Banking and Financial Studies 2005,09, Deutsche Bundesbank, Research Centre. [Downloadable!]
    Other versions:
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Cited by:
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  1. Dairo Estrada & Angela González Arbelaéz & Javier Gutiérrez Rueda, . "The Effects of Diversification on Banks’ Expected Returns," Borradores de Economia 524, Banco de la Republica de Colombia. [Downloadable!]
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  2. Francisco F. Vázquez & Alicia García-Herrero, 2007. "International Diversification Gains and Home Bias in Banking," IMF Working Papers 07/281, International Monetary Fund. [Downloadable!]
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