Business model diversity and banking sector resilience

What is the impact of the diversity of business models operating in a banking sector and its resilience? Literature offers mixed predictions: while one strand of literature puts emphasis on the virtues of diversity due to lower contagion, an opposing strand suggests that nudging banks to choose diverse diversification strategies (which tend to be individually sub-optimal) may be ‘a worse remedy than the disease’. This paper provides several contributions to this discussion: (i) the development of a two-step measure of business model diversity, based on the application of clustering techniques on a set of business model variables at the bank level, followed by their aggregation at the country level, (ii) the specification of a 3SLS model that explicitly considers the interactions of business model diversity with diversification and market power in explaining banking sector resilience, (iii) the breakdown of the baseline results per type of financial system (i.e. bank vs market-based), and (iv) the analysis of the diversity and composition of optimal country-level portfolios of banking business models. In general, our results suggest that more resilient banking sectors tend to be more diverse (i.e., assets are well distributed across different bank types), less revenue diversified and exhibit more market power than less resilient ones. Additionally, a deeper dive tells us that such relationship between diversity and resilience seems to occur chiefly in market-based systems. Finally, the analysis of efficient portfolios confirms that a similar level of diversity may induce different resilience responses according to the type of financial system, which we attribute to the ‘ecosystem’ of each type of financial system. Our results are robust to changes to the original model specification, proxies for dependent and independent variables, and sample composition.