Income diversity, ownership concentration and credit risk in commercial banks: Does bank growth matters?

Purpose: The equivocal impact of income diversity on credit risk in various economies under different circumstances has impelled this study to explore the empirical association between credit risk and income diversity. This study recognizes the significant role of ownership concentration, particularly within Pakistan, and aims to explore how ownership concentration influences credit risk. Moreover, this study has addressed an unresolved gap by investigating how income diversity in the presence of bank growth impacts credit risk in commercial banks of Pakistan. This study used the dynamic two-step GMM panel data estimator system. To address over-identifying restrictions, this study used the Hansen J statistic for instrument validity. The Arellano–Bond test was also applied to check for serial autocorrelation. This research utilized a balanced panel dataset of 198 bank-year observations from 22 commercial banks in Pakistan, spanning a decade from 2007 to 2017. Z score is used to measure credit risk. The study reveals that income diversity positively affects stability in Pakistani commercial banks, mitigating risk. In contrast, bank growth has a detrimental effect on stability, with larger institutions exhibiting lower stability than smaller ones. Additionally, high ownership concentration undermines bank stability and elevates risk by granting substantial influence to major shareholders over investment decisions. Thus, while income diversity contributes to enhanced stability, bank growth and high ownership concentration are associated with reduced stability. The findings of this study imply that Pakistan’s banks are under-diversified. Enhanced diversification can benefit banks in the early phases of growth. However, more diversification in large-grown banks might deteriorate stability. High ownership concentration in banks has a damaging effect on bank stability. Small and less mature banks are better able to diversify than large banks. Policymakers should encourage banks working below the optimal level to diversify more to increase the stability and profitability of banks and must discourage large-grown banks from diversifying beyond the optimal limits because it can endanger their existence. For the first time, this study explored how income diversity affects bank risk under varying conditions. It advances academic understanding by examining how growth interacts with income diversity to affect credit risk. Furthermore, the research highlights the detrimental impact of high ownership concentration on bank stability.