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Does Diversification Improve the Performance of German Banks? Evidence from Individual Bank Loan Portfolios

  • Evelyn Hayden

    ()

    (Oesterreichische Nationalbank, Banking Analysis and Inspections Division)

  • Daniel Porath

    ()

    (Deutsche Bundesbank, Banking and Financial Supervision Department)

  • Natalja von Westernhagen

    ()

    (Deutsche Bundesbank, Banking and Financial Supervision Department)

Should banks be diversified or focused? Does diversification indeed lead to increased performance and therefore greater safety on the part of banks as traditional portfolio and banking theory would suggest? This paper investigates the link between banks’ profitability and their portfolio diversification across different industries, broader economic sectors and geographical regions. 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. Additionally, we find that banks do not use diversification to operate at a constant level of risk-return efficiency, which implies that banks are not risk-return efficient. Moreover, we find that the impact of diversification strongly depends on the risk level. However, only for moderate risk levels and in the case of industrial diversification does diversification significantly improve the banks’ returns.

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Paper provided by Oesterreichische Nationalbank (Austrian Central Bank) in its series Working Papers with number 110.

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Length: 37
Date of creation: 09 Jan 2006
Date of revision:
Handle: RePEc:onb:oenbwp:110
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  2. Kevin J. Stiroh, 2002. "Diversification in banking: is noninterest income the answer?," Staff Reports 154, Federal Reserve Bank of New York.
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  13. Stiroh, Kevin J. & Rumble, Adrienne, 2006. "The dark side of diversification: The case of US financial holding companies," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2131-2161, August.
  14. 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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  17. 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.
  18. Joseph P. Hughes & William W. Lang & Loretta J. Mester & Choon-Geol Moon, 1996. "Safety in numbers? Geographic diversification and bank insolvency risk," Proceedings 504, Federal Reserve Bank of Chicago.
  19. von Kalckreuth, Ulf, 2005. "A "wreckers theory" of financial distress," Discussion Paper Series 1: Economic Studies 2005,40, Deutsche Bundesbank, Research Centre.
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