Diversification and the Cost of Debt of Bank Holding Companies

Abstract

In this study, we investigate the relationship between various dimensions of diversification and the cost of debt for publicly traded bank holding companies (BHCs). We find that both domestic geographic diversification of deposits and diversification of assets lead to a lower bond yield-spread. Diversification of non-traditional banking activities leads to a lower cost of debt only when yield-spread and diversification are estimated simultaneously. In addition, we find that medium-sized BHCs experience a greater reduction in bond yield-spread than small-sized and large-sized BHCs. This is consistent with the too-big-to-fail (TBTF) effects in the banking industry. Furthermore, we document that the association between diversification and yield-spread is bidirectional with higher yield-spreads being associated with greater asset and activity diversification and lower geographic deposit dispersion. The effect of diversification on bond yield-spread is robust after accounting for cross-sectional and serial correlation, and the endogeneity of diversification.

Keywords: Bank holding company, diversification, cost of debt

JEL Classification: G21