The potential for portfolio diversification in financial services

The Gramm-Leach-Bliley Act sweeps away most of the barriers limiting the affiliation of banks with nonbank financial services providers. The focus now shifts to financial services executives who must decide which combinations provide the best opportunities to increase shareholder wealth. Existing empirical evidence suggests that an important consideration in this decision is the potential gain from portfolio diversification into new activities. The empirical evidence also suggests that the potential for such gain clearly exists. ; This article builds on earlier studies, in particular updating the contribution of Wall, Reichert, and Mohanty (1993). After reviewing studies since the 1993 article of the potential gains from diversification, the authors summarize the legal changes resulting from passage of the Gramm-Leach-Bliley Act. The article then updates the 1993 analysis of return on assets using data from the Internal Revenue Service (IRS) to cover the 1991-97 period and also examines return on equity from 1991 to 1997. ; The new empirical results are consistent with the prior study in finding substantial potential gains from diversification using IRS data. The results also support the earlier finding that the efficient combinations (lowest risk for any given level of return) vary through time, perhaps for reasons such as the macroeconomic environment or technology. For bankers, one positive change in the 1991-97 period over the 1970s and 1980s is that banks have become a larger part of the efficient financial services portfolio.