The Effects of Focus versus Diversification on Bank Performance: Evidence from Chinese Banks

Abstract

This paper investigates the effects of focus versus diversification on bank performance using data on Chinese banks during the 1996-2006 period. We construct a new measure, economies of diversification, and compare the results to those of the more conventional focus index, which is based on the sum of squares of shares in different products or regions. Diversification is captured in four dimensions: loans, deposits, assets, and geography. We find that all four dimensions of diversification are associated with reduced profits and higher costs. These results are robust regardless of alternative measures of diversification and performance. Furthermore, we observe that banks with foreign ownership (both majority and minority ownership) and banks with conglomerate affiliation -are associated with fewer diseconomies of diversification, suggesting that foreign ownership and conglomerate affiliation play an important mitigating role. This analysis may provide important implications for bank managers and regulators in China as well as in other emerging economies.

Evaluating the effectiveness of China's financial reform—The efficiency of China's domestic banks

“…Therefore, we replace quantity of outputs in Eq. (8) with the prices of outputs, where the price of loans is measured by the ratio of interest income from loans to total loans, the price of other earning assets is measured by the ratio of interest income from other earning assets to other earning assets, and the price 6 Total cost and three outputs are divided by total assets to control for potential scale bias following Berger et al (2009Berger et al ( , 2010, Fu and Heffernan (2007), Akhigbe and McNulty (2003). 7 We add non-interest income as a proxy for non-traditional activities of banks such as loan commitment, letters of credit, bank acceptance, and services on deposit accounts.…”

“…To study the first issue, we follow Berger, Hasan, and Zhou (2010) to define the economy of scope as the proportional increase in profits from producing all outputs jointly by a diversified bank compared to producing each output individually by hypothetical focused banks. More specifically,…”

“…A translog function is not suitable to study this issue because of the difficulty in determining the value of π(y 1 , 0) and π(0, y 2 ). Therefore, we follow Pulley and Braunstein (1992) and Berger et al (2010) to specify a composite function of the form…”

“…(7). Following Berger et al (2010), we divide π and y j by total assets to control size heterogeneity and divide π and w i by w 3 to reflect price homogeneity. The nonlinear least square method is employed to estimate the parameters of Eq.…”

Ownership, diversification and cost advantages: Evidence from the Italian leasing industry

“…Despite the large number of studies, there appears to be no consensus on the effects of diversification on banks' economic profile (see the recent analysis by Berger et al, 2010). Some studies, however, have found evidence that financial institutions should focus on a single line of business to benefit from management expertise for different reasons: to reduce agency costs (Acharya et al, 2006;Laeven and Levine, 2007); to reduce the sources of risk (Fauver et al, 2004;Deng and Elyasiani, 2008); or to maintain profitability (Stiroh, 2004).…”