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

  • 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)

Registered author(s):

    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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    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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    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. 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.
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    7. 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.
    8. 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.
    9. Allen N. Berger & Anthony Saunders & Joseph M. Scalise & Gregory F. Udell, 1998. "The Effects of Bank Mergers and Acquisitions on Small Business Lending," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-007, New York University, Leonard N. Stern School of Business-.
    10. Larry H.P. Lang & Rene M. Stulz, 1993. "Tobin's Q, Corporate Diversification and Firm Performance," NBER Working Papers 4376, National Bureau of Economic Research, Inc.
    11. Robert A. Eisenbeis & Myron L. Kwast, 1989. "Are real estate specializing depositories viable? The evidence from commercial banks," Finance and Economics Discussion Series 88, Board of Governors of the Federal Reserve System (U.S.).
    12. Winton, Andrew, 1997. "Competition among Financial Intermediaries When Diversification Matters," Journal of Financial Intermediation, Elsevier, vol. 6(4), pages 307-346, October.
    13. 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.
    14. Ralph C. Kimball, 1997. "Specialization, risk, and capital in banking," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 51-73.
    15. 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.
    16. 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.
    17. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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