Should banks be diversified or focused? Does diversification indeed lead to enhanced performance and, therefore, greater safety for banks, as traditional portfolio and banking theory would suggest?This paper investigates the link between banks' profitability (ROA) and their portfolio diversification across different industries, broader economic sectors and geographical regions measured by the Herfindahl Index. 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. Moreover, we find that the impact of diversification depends strongly on the risk level. However, it is only for moderate risk levels and in the case of industrial diversification that diversification significantly improves the banks' returns.Keywords: focus, diversification, monitoring, bank returns, bank risk JEL Classification: G21, G28, G32 Non-Technical SummaryShould banks be diversified or focused? Does diversification indeed lead to enhanced performance and therefore greater safety for banks as traditional portfolio and banking theory would suggest? In this paper we try to shed some light on these questions by empirically investigating the situation for German banks. By exploiting a unique data set of individual bank loan portfolios for the period from 1996 to 2002, we analyse the link between banks' profitability measured by ROA and their portfolio diversification measured by the Herfindahl Index across different industries, broader economic sectors and geographical regions. To the best of the authors' knowledge, this is the first paper to study the effect of all three types of diversification based jointly on micro-level data on German banks.The relevant academic literature puts forward two conflicting theories concerning the optimal degree of diversification. While traditional banking and portfolio theory recommends that banks should be as diversified as possible to reduce their risks of suffering a costly bank failure, corporate finance theory suggests that a bank should focus so as to obtain the greatest possible benefit from management's expertise and to reduce agency problems.Our results clearly support the latter theory, as the evidence we present indicates that each kind of diversification tends to lower German banks' returns, ie focusing generally increases profitability.Furthermore, the impact of any diversification on banks' return changes in line with the risk level.While the effect of sectoral focus on return declines monotonously with increasing risk, there is mixed evidence to suggest either a monotonously decreasing or a U-shaped relationship for regional focus as well as a rather distinct indication of a U-shape with respect to industrial focus. In addition, our data shows that diversification significantly improves banks' profits only in the case of mo...
Should banks be diversified or focused? Does diversification indeed lead to enhanced performance and, therefore, greater safety for banks, as traditional portfolio and banking theory would suggest?This paper investigates the link between banks' profitability (ROA) and their portfolio diversification across different industries, broader economic sectors and geographical regions measured by the Herfindahl Index. 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. Moreover, we find that the impact of diversification depends strongly on the risk level. However, it is only for moderate risk levels and in the case of industrial diversification that diversification significantly improves the banks' returns.Keywords: focus, diversification, monitoring, bank returns, bank risk JEL Classification: G21, G28, G32 Non-Technical SummaryShould banks be diversified or focused? Does diversification indeed lead to enhanced performance and therefore greater safety for banks as traditional portfolio and banking theory would suggest? In this paper we try to shed some light on these questions by empirically investigating the situation for German banks. By exploiting a unique data set of individual bank loan portfolios for the period from 1996 to 2002, we analyse the link between banks' profitability measured by ROA and their portfolio diversification measured by the Herfindahl Index across different industries, broader economic sectors and geographical regions. To the best of the authors' knowledge, this is the first paper to study the effect of all three types of diversification based jointly on micro-level data on German banks.The relevant academic literature puts forward two conflicting theories concerning the optimal degree of diversification. While traditional banking and portfolio theory recommends that banks should be as diversified as possible to reduce their risks of suffering a costly bank failure, corporate finance theory suggests that a bank should focus so as to obtain the greatest possible benefit from management's expertise and to reduce agency problems.Our results clearly support the latter theory, as the evidence we present indicates that each kind of diversification tends to lower German banks' returns, ie focusing generally increases profitability.Furthermore, the impact of any diversification on banks' return changes in line with the risk level.While the effect of sectoral focus on return declines monotonously with increasing risk, there is mixed evidence to suggest either a monotonously decreasing or a U-shaped relationship for regional focus as well as a rather distinct indication of a U-shape with respect to industrial focus. In addition, our data shows that diversification significantly improves banks' profits only in the case of mo...
Most of the literature addressing multiple banking assumes equal financing shares. However, unequal, concentrated or asymmetric bank borrowing is widespread. This paper investigates the determinants of creditor concentration for German firms using a comprehensive bank-firm level dataset for the time period between 1993 and 2003. We document that lending is very often concentrated and, consequently, that relationship lending is important, not only for the small firms but also for the larger firms in our sample.However, we also find that risky, illiquid, large and leveraged firms spread their borrowing more evenly between multiple lenders. On the other hand, the degree of concentration increases with the profitability of the relationship lender. Relationship lending may spur financing provided by other banks, especially if the relationship lender is a public sector bank and if the other banks are large or do not have to tie up additional funds in capital.
Most of the literature addressing multiple banking assumes equal financing shares. However, unequal, concentrated or asymmetric bank borrowing is widespread. This paper investigates the determinants of creditor concentration for German firms using a comprehensive bank-firm level dataset for the time period between 1993 and 2003. We document that lending is very often concentrated and, consequently, that relationship lending is important, not only for the small firms but also for the larger firms in our sample. However, we also find that risky, illiquid, large and leveraged firms spread their borrowing more evenly between multiple lenders. On the other hand, the degree of concentration increases with the profitability of the relationship lender. Relationship lending may spur financing provided by other banks, especially if the relationship lender is a public sector bank and if the other banks are large or do not have to tie up additional funds in capital.
Research Question By mid-2006 real estate prices in the US began to plummet, triggering the US subprime mortgage crisis that led to a global financial crisis. German banks, too, experienced considerable loan losses and ensuing capital constraints. This was largely attributed to their various exposures to the US real estate market. In addition to their direct lending to US firms in the real estate sector and to major subprime lenders, German banks also became exposed by providing liquidity support in the form of credit lines to their asset-backed commercial paper (ABCP) conduits. For that reason, we investigate how each type of exposure in the US influenced domestic lending in Germany. We focus on the heterogeneity in the contraction taking place across banks and firms. We are mainly interested in seeing whether-when home prices started to decline in the US-differences in bank exposures to the US real estate market started to determine bank lending in Germany according to firm risk. Nichttechnische Zusammenfassung Fragestellung Als Mitte 2006 die Immobilienpreise in den USA zu stürzen begannen, wurde die Subprime-Krise in den USA ausgelöst, die zu einer globalen Finanzkrise geführt hat. Auch deutsche Banken erlebten erhebliche Kreditausfälle und mussten die daraus resultierenden Kapitaleinbußen verkraften. Dies war im Wesentlichen auf ihre verschiedenen Engagements am US-Immobilienmarkt zurückzuführen. Neben ihrer direkten Kreditvergabe an die US-Firmen im Immobiliensektor und an die wichtigsten Subprime-Kreditgeber wurden die deutschen Banken auch durch die Bereitstellung von Liquiditätshilfen in Form von Kreditlinien, um ihre außerbilanziellen Geschäftseinheiten zu unterstützen, dem US-Hauspreisschock ausgesetzt. Aus diesem Grund untersuchen wir, wie jede Art der US-Engagements deutscher Banken die inländische Kreditvergabe in Deutschland beeinflusst hat. Wir untersuchen vor allem die Heterogenität bei dem Rückgang der inländischen Kreditvergabe. Uns interessiert primär die Frage, ob-als die Immobilienpreise in den USA zu sinken begannen-die inländische Kreditvergabe der Banken durch die Unterschiede in ihren Engagements in dem US-Immobilienmarkt und in Abhängigkeit vom Unternehmensrisiko in Deutschland beeinflusst wurde. Beitrag Eine Reihe von Eigenschaften unterscheidet unser Papier eindeutig von früheren Arbeiten. Erstens ermöglicht uns der Zugang zu vertraulichen bankaufsichtlichen Einzeldaten die tatsächlichen zeitlich variierenden Engagements in dem US-Immobilienmarkt aller deutschen Banken zu bestimmen. In Kombination mit dem drastischen Rückgang der US-Immobilienpreise ermöglicht uns diese Information, die mutmaßlichen Verluste der Banken zu identifizieren. Zweitens greifen wir auf das Kreditregister zu, das den gesamten Bankensektor in Deutschland abdeckt, um die Änderungen in der Kreditvergabe zu untersuchen. Schließlich untersuchen wir nicht nur das resultierende Volumen im Aggregat, sondern auch die Zusammensetzung der Kreditvergabe der Banken in Deutschland über Unternehmen, Branchen und Regionen. E...
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