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Specialization, risk, and capital in banking

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  • Ralph C. Kimball

Abstract

Diversification is certainly the simplest and perhaps the oldest approach to managing the trade-off between portfolio risk and return. Because diversification tends to reduce risk without a proportional reduction in returns, an overwhelming majority of commercial banks have diversified portfolios. Larger banks usually are organized into multiple specialized lines of business; smaller banks generally hold a higher proportion of marketable securities whose returns are not tied to a particular geographic market. A much smaller number of banks have chosen to ignore the benefits of diversification and focus on a particular asset such as credit cards, residential or commercial real estate, corporate trust services, or small business lending.> This article investigates specialization in banking and its effects on risk and return. The author compares a group of banks specializing in small business micro-loans (loans under $100,000) with a matched set of diversified peers. The number of specialized banks is still small, but they are expected to become more prevalent, and the number of specialized nonbanks is large, including commercial and consumer finance companies, mortgage banks, leasing companies, many thrift institutions, and some investment banks and insurance companies. The author discusses the issues that specialization creates for regulators, especially in the field of capital requirements, and the need to revise the current approach to regulatory risk-based capital to better distinguish between specialized and diversified banks.

Suggested Citation

  • Ralph C. Kimball, 1997. "Specialization, risk, and capital in banking," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 51-73.
  • Handle: RePEc:fip:fedbne:y:1997:i:nov:p:51-73
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    References listed on IDEAS

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    Cited by:

    1. Khemais Zaghdoudi & Abdelaziz Hakimi, 2017. "The Determinants of Liquidity Risk: Evidence from Tunisian Banks," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 7(2), pages 1-5.
    2. Sherrill Shaffer, 2008. "Financial Performance Of Small Business Loans: Indirect Evidence," CAMA Working Papers 2008-28, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    3. James W. Kolari & Charles C. Ou & G. Hwan Shin, 2006. "Assessing the Profitability and Riskiness of Small Business Lenders in the Banking Industry," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 11(2), pages 1-26, Summer.
    4. John S. Jordan, 1998. "Problem loans at New England banks, 1989 to 1992: evidence of aggressive loan policies," New England Economic Review, Federal Reserve Bank of Boston, issue Jan, pages 23-38.

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