Should Banks Be Diversified? Evidence from Individual Bank Loan Portfolios
Posted: 8 Jun 2004
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Should Banks Be Diversified? Evidence from Individual Bank Loan Portfolios
Abstract
We study the effect of loan portfolio focus vs. diversification on the return and the risk of 105 Italian banks over the period 1993-1999 using data on bank-by-bank exposures to different industries and sectors. We find that diversification is not guaranteed to produce superior performance and/or greater safety for banks. For high-risk banks, diversification reduces bank return while producing riskier loans. For low-risk banks, diversification produces either an inefficient risk-return tradeoff or only a marginal improvement. Our results are consistent with a deterioration in the effectiveness of bank monitoring at high risk-levels and upon lending expansion into newer or competitive industries.
Keywords: Focus, Diversification, Monitoring, Bank risk, Bank return
JEL Classification: G21, G28, G31, G32
Suggested Citation: Suggested Citation
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