Chiến lược đa dạng hóa, hiệu quả và rủi ro của ngân hàng Bằng chứng thực nghiệm tại Việt Nam.Chiến lược đa dạng hóa, hiệu quả và rủi ro của ngân hàng Bằng chứng thực nghiệm tại Việt Nam.Chiến lược đa dạng hóa, hiệu quả và rủi ro của ngân hàng Bằng chứng thực nghiệm tại Việt Nam.Chiến lược đa dạng hóa, hiệu quả và rủi ro của ngân hàng Bằng chứng thực nghiệm tại Việt Nam.Chiến lược đa dạng hóa, hiệu quả và rủi ro của ngân hàng Bằng chứng thực nghiệm tại Việt Nam.
INTRODUCTION
Research motivation
In 1952, Nobel Laureate Harry Markowitz mathematically proved that concentrating investments in a single asset is a highly risky strategy, while diversification offers a near "free lunch" for investors and business managers This groundbreaking insight sparked a transformative intellectual movement that reshaped Wall Street, corporate finance, and global business decision-making, with lasting impacts that continue to resonate today.
Diversification in the banking sector has sparked debate regarding its effects on risk and performance Proponents argue that diversification offers significant advantages over focused banking strategies, including the ability to leverage managerial expertise across different products and regions, benefit from economies of scale by distributing fixed costs across various markets, and provide a comprehensive array of financial services to clients with diverse needs.
Proponents of the concentration strategy argue that diversified banks may diminish their comparative management advantage by venturing into areas outside their expertise (Klein & Saidenberg, 1998) Additionally, diversification can lead to increased competition (Winton, 1999) and higher agency costs due to reduced value activities as managers seek to minimize risk (L Laeven & Levine, 2007).
The empirical literature on banking diversification first addresses developed markets, where banks have been fully mature, such as the US market and other
Research on banking performance has been conducted in 13 developed European countries (Baele et al., 2007; Curi et al., 2015; Elsas et al., 2010; Mercieca et al., 2007; Stiroh & Rumble, 2006), as well as in emerging and transition economies (Chen et al., 2018; Moudud-Ul-Huq et al., 2018) However, findings vary significantly across different countries and regions (Nguyen, 2018), highlighting the complexity of banking performance analysis as noted by Doumpos, Gaganis, and Pasiouras.
(2016), diversification can be more beneficial for banks operating in less developed countries compared to banks in advanced and major advanced countries.
Vietnam stands out as one of the fastest-growing emerging markets, marked by significant political and economic reforms, while uniquely operating as a market-driven economy within a socialist framework The banking sector is vital to the country's economic landscape, serving as the primary source of both short and long-term funding for firms, particularly private enterprises Dominated by State-owned commercial banks, which hold over 70% of owner equity and account for roughly 50% of market shares, the Vietnamese banking system plays a crucial role in the financial infrastructure However, this dominance often leads to a lack of motivation among these banks to enhance profitability and efficiency, given their large customer base and state backing.
1 There are four biggest State-owned commercial banks, including Vietnam Bank for Agriculture and Rural
The Joint Stock Commercial Bank for Investment and Development of Vietnam, the Vietnam Joint Stock Commercial Bank of Industry and Trade, and the Joint Stock Commercial Bank for Foreign Trade of Vietnam are key financial institutions driving economic growth in Vietnam These banks play a crucial role in providing investment, trade, and foreign exchange services, contributing significantly to the country's banking sector and overall development.
Vietnamese banks historically focused on traditional interest-bearing activities and interbank lending However, following Vietnam's entry into the World Trade Organization (WTO) in 2007 and the emergence of five wholly-owned foreign bank subsidiaries, competition in the lending and deposit markets intensified As a result, Vietnamese banks have been compelled to move beyond their conventional business models and diversify into non-traditional activities (Le, 2015; P A Nguyen & Simioni, 2015).
The 2008 real estate bubble burst in the United States triggered a global subprime mortgage crisis and subsequent financial turmoil, leading to a slowdown in world economic growth amidst rising inflationary pressures that challenged central banks' monetary policies The impact varied across economies, with major players like the US, Europe, and Japan experiencing severe repercussions, including negative economic growth, business failures, and rising unemployment This ongoing financial market instability has fostered negative sentiment, rooted in a credit crunch and concentration risk within banks' credit portfolios.
Vietnam has been significantly impacted by the global financial crisis, experiencing a decline in production and business activities, a drop in industrial production value, and rising unemployment The credit relationship between banks and customers has also faced challenges due to difficulties in product production and consumption Economic indicators have shown a dramatic downturn since 2009, worsening between 2011 and 2014, with GDP growth falling to 4.8% in 2011—the lowest since 1999 Additionally, inflation rates surged uncontrollably, reaching double digits by the end of 2010, while total investment, primarily from the state sector, decreased from approximately 40% of GDP to around 30%.
Between 2011 and 2014, Vietnam's economy experienced significant challenges, including depressed real estate prices due to rising real interest rates and a slowdown in capital flows The country faced a high trade deficit, nearing a critical budget deficit, alongside increasing public debt.
The Vietnamese financial market and banking industry faced significant challenges, marked by a slowdown in credit growth and a sharp rise in non-performing loans, which severely impacted commercial banks Key issues included bad loans, liquidity shortages, and overall poor performance across the sector Bank managers exhibited weaknesses such as inadequate capital buffers, ineffective management skills, and insufficient risk management strategies Following the Global Financial Crisis (GFC) in 2008-2009, rapid credit expansion without proper oversight led to deteriorating asset and credit quality, contributing to the banking distress experienced from 2011 to 2014 The concentration risk within banks' credit portfolios heightened contagion risks in the banking system, with non-performing loans rising dramatically from under 5% of total bank capital in 2011 to nearly 12% in 2012 and around 15% in 2014, as reported by Fitch Ratings and Moody’s Investor Service.
2015) The number of banks reduced from 52 in 2011 to 43 in 2015 (see Table1.1) because of many insolvency cases and mergers & acquisitions A dozen of weak banks were eliminated.
To address the challenges facing the banking sector, the Vietnamese government initiated a comprehensive restructuring program from 2011 to 2015 This initiative, as outlined in Prime Minister Decision No 254/QD-TTg dated March 1, 2012, mandates commercial banks to enhance asset quality and diversify their operations into non-credit services, reducing their dependence on traditional credit activities.
In 2016, the State Bank of Vietnam mandated the adoption of Basel II, categorizing assets into five classes: corporate, sovereign, bank, retail, and equity, along with their sub-classes In response to government directives, Vietnamese banks are now implementing diversification strategies to enhance the quality of their assets, liabilities, and income.
Table 1.1: Descriptive number of banks in Vietnam, 2005-2019
Source: State Bank of Vietnam, System of Credit Institutions, 2020
Banks can choose from a range of diversification strategies for assets, funding, and income based on their current strength and resources By leveraging these resources, banks can expand and diversify their business activities across multiple areas.
State-owned commercial banks, as defined by the State Bank of Vietnam under the new Corporate Law 2015, aim to limit risks and enhance revenue while balancing risk control with profitability Conflicting regulations and supervisory practices can lead banks to choose between diversification and concentration strategies While some banks may focus on specific areas due to restrictions on branches, entry, and investments, others may prioritize risk reduction and adopt a diversification strategy to mitigate potential losses.
Research background
Economic theories present varied perspectives on diversification, particularly in the context of modern portfolio theory, which posits that diversification mitigates specific risks The adage "do not put all your eggs in one basket" underscores the importance of creating a diverse investment portfolio to minimize risk (Fama & Jensen, 1985) Engaging in non-correlated activities, such as both interest and non-interest income sources, can provide banks with stability and reduce income fluctuations (Tabak, Fazio, & Cajueiro, 2011; Winton, 1999) This aligns with modern investment theory (Haugen & Haugen, 2001), suggesting that banks can enhance their resilience against failures by diversifying their resource allocation across multiple sectors.
According to agency problem theory, diversification can lead to increased agency problems, resulting in higher agency costs and potential opportunity costs Overconfident managers may make poor diversification choices, negatively impacting bank performance Additionally, the unique nature of banks means that findings from general corporate finance literature may not be applicable to the banking sector.
Despite numerous studies on banking diversification and its performance, scholars have yet to reach a consensus due to conflicting empirical results Proponents of diversification argue that it offers distinct advantages over focused banking, including the ability to leverage managerial skills across different products and regions, capitalize on economies of scale by distributing fixed costs, and provide a comprehensive range of financial services to clients with diverse needs Conversely, advocates of concentration strategies contend that diversified banks may diminish their comparative management advantages by venturing into areas outside their expertise.
1998) Furthermore, diversification increases competition (Winton, 1999) and creates higher agency costs resulting from activities of diminishing value when managers want to reduce their risk (Amihud & Lev, 1981; L Laeven & Levine, 2007).
Before 2010, most research on banking diversification focused on developed markets like the US and Europe, where banks were well-established (Acharya et al., 2006; Curi et al., 2015; Elsas et al., 2010; Mercieca et al., 2007; Rossi et al., 2009; Stiroh & Rumble, 2006; Yang et al., 2020) In contrast, there is significantly less scholarly attention on this subject within emerging and transition economies, with only a few notable studies addressing the topic (Odesanmi & Wolfe, 2007; Berger et al., 2010).
In the past decade, researchers have increasingly focused on the relationship between diversification, bank risk, and performance, particularly in developing and emerging markets Notably, studies in Asia have examined groups of developing countries (N Chen et al., 2018; Moudud-Ul-Huq et al., 2018), while others have concentrated on individual nations, including Brazil (Tabak et al., 2011), China (A N Berger, Hasan, & Zhou, 2010), and the Philippines (Meslier, Tacneng).
& Tarazi, 2014), Ghana (Duho, Onumah, & Owodo, 2019), or Vietnam (Batten
The topic of diversification in banking continues to attract significant attention from researchers and managers globally Empirical studies indicate that the effectiveness of diversification strategies varies by country, with banks in less developed regions reaping greater benefits compared to their counterparts in developed nations Additionally, the impact of diversification differs markedly between bank-based economies, such as Vietnam, and market-based economies.
In Vietnam, the impact of diversification on banking risk and performance has sparked conflicting arguments, leading to uncertainty about its benefits This has garnered significant interest from researchers and policymakers Previous studies have examined asset, income, and funding diversifications within the Vietnamese banking system, particularly in comparison to 5 to 6 Asian countries Findings indicate that banks with greater foreign-owned asset diversification achieve higher profit efficiency; however, this benefit appears to be short-lived, lacking long-term effectiveness Some researchers argue that diversification is a crucial strategy for mitigating risks in Vietnamese banks, with evidence suggesting that increased funding diversification can significantly enhance profitability.
Banking diversification is often analyzed through investor insights and the role of funding liquidity in influencing bank risk and performance Research indicates that while funding diversification can enhance bank profitability, it may also lead to riskier decision-making However, existing studies typically focus on revenue or funding diversification in isolation, with limited exploration of asset diversification Furthermore, there is a lack of systematic research on how diversification strategies affect bank risk and return during financial distress, as well as on the combined effects of these strategies, which could provide bankers with optimal diversification portfolio models for various economic conditions.
Research gap identification
This research enriches the literature on bank diversification, risk, and performance in Vietnam by addressing critical gaps It poses an intriguing question: Do diversification strategies significantly influence the performance and risk of Vietnamese banks, particularly during banking crises? Furthermore, it emphasizes the necessity for banks to simultaneously implement all three diversification strategies Consequently, the study aims to explore effective methods for banks to integrate these strategies to meet their desired risk-return objectives.
This dissertation analyzes the differences in risk and return between diversified and concentrated banks in Vietnam from 2005 to 2019 Focusing on a single country is essential due to its unique economic and political characteristics The fifteen-year timeframe provides a robust foundation for econometric modeling, making it an ideal choice for this study.
2019 Moreover, banking data are not adequate before 2005, with many missing figures.
This dissertation examines the impact of diversification on risk and performance during the Vietnamese banking distress period from 2011 to 2014 Dziobek and Pazarbasioglu (1998) analyzed government response policies to crises across 24 countries and identified 13 types of interventions Notably, four key policies are relevant to the Vietnamese banking and financial crisis from 2005 to 2019: government and central bank liquidity interventions, the establishment of a nonperforming loan management unit, the takeover of distressed banks, and the consolidation of crisis banks.
This dissertation explores how the relationship between diversification, bank performance, and risk varies across different bank ownership types A review of existing literature reveals a gap in research regarding the impact of various diversity strategies on the performance and risk of Vietnamese banks Additionally, no previous studies have addressed whether this relationship differs among banks with distinct ownership structures Consequently, the Vietnamese banking sector presents a compelling case for examining the connections between banking diversity, risk, and performance.
Research objectives
Diversification has long been viewed as a strategy to enhance bank risk management and performance; however, recent financial turmoil has sparked debate over its effectiveness Despite numerous empirical studies examining the link between diversification strategies and bank profitability, a consensus among researchers remains elusive due to varying results across different countries The evidence regarding the effects of asset, income, and funding diversification on bank performance and risk is particularly inconsistent, highlighting the complexity of this relationship across regions.
This dissertation aims to assess the level of bank diversification among Vietnamese commercial banks and analyze its effects on both risk and performance, drawing on insights from prior research in the diversification literature.
Between 2005 and 2019, diversification strategies in banking were analyzed across three key dimensions: assets, funding, and income These dimensions encompass both sides of the balance sheet and the bank's income statement Additionally, the study explores the varying impacts of integrating these diversification strategies to develop optimal models for banks.
This dissertation examines the effects of diversification on banking risk and performance in Vietnam during the banking distress period from 2011 to 2014 It aims to provide practical recommendations for bank managers and regulatory authorities in emerging markets, focusing on how to adjust diversification strategies and monetary policies to enhance the risk management and financial performance of the banking system amid economic turmoil.
This dissertation aims to systematically explore how ownership strategies, particularly those involving state-owned banks and subsidiaries of foreign banks, influence the relationship between diversification, risk, and performance.
This dissertation employs secondary data, quantitative methods, and econometric models to analyze the Vietnamese banking system, a notable frontier economy The findings and methodologies presented here offer a foundation for future research in this area.
Research questions
This dissertation analyzes the impact of bank diversification on performance and risk in Vietnam by utilizing panel data from 34 banks between 2005 and 2019, employing econometric methods It particularly focuses on the banking distress period from 2011 to 2014, aiming to address specific research questions aligned with its objectives.
Research question 1: Do diversification strategies (asset, income, funding) and their combinations impact bank risk and performance?
RQ1.1: Does asset diversification impact bank risk and performance?
RQ1.2: Does income diversification impact bank risk and performance?
RQ1.3: Does funding diversification impact bank risk and performance?
RQ1.4: Can banks combine these three diversification strategies to achieve their expected risk-performance objectives?
Research question 2: Do diversification strategies (asset, income, funding) impact bank risk and performance in the banking distress period?
RQ2.1: Do diversification strategies impact bank risk during banking distress?
RQ2.2: Do diversification strategies impact bank performance during banking distress?
Research question 3: Do bank ownership structures impact the diversification- risk-performance nexus?
RQ3.1: Do ownership structures impact the diversification-risk nexus?
RQ3.2: Do ownership structures impact diversification-performance nexus?
The scope of research
This dissertation explores the effects of different diversification strategies—asset, income, and funding—on the financial risk and performance of Vietnamese commercial banks, particularly during periods of banking distress It also considers the influence of bank ownership structures The study analyzes a sample of 34 commercial banks in Vietnam, comprising 4 state-owned banks (3 of which are publicly listed), 5 foreign-owned banks, and 25 domestic private banks, collectively representing over 90% of the country's banking sector.
This research spans from 2005 to 2019, utilizing secondary data sourced from reliable financial reports of commercial banks obtained from platforms like Bankscope, OrbisBankFocus, and Vietstock Notably, this timeframe includes the distress period of the Vietnamese banking system from 2011 to 2014.
Research procedure and methodology
A study was conducted using annual financial statements from 34 Vietnamese commercial banks between 2005 and 2019, sourced from the Bankscope and Orbis Bank Focus databases The research aimed to analyze how different aspects of diversification affect various indicators of bank performance and risk.
The research employs three estimation techniques: Pool OLS, Fixed Effects Model (FEM), and Random Effects Model (REM), alongside the System Generalized Method of Moments (SGMM) While the Pool OLS model has limitations (Kiviet, 1995), FEM and REM effectively address individual effects However, since these models do not account for endogenous phenomena (Ahn & Schmidt, 1995), the System GMM technique is utilized to tackle these issues (Hansen, 1982) Additionally, the System GMM method provides stable, normally distributed, and efficient coefficients.
We utilize the two-step system GMM (SGMM) estimation method, as proposed by Arellano and Bover (1995) and Blundell and Bond (1998), to effectively analyze panel data characterized by a large number of cross-sectional observations over a shorter time frame This advanced SGMM approach is applied across all our empirical models, addressing potential endogeneity concerns that could skew the results regarding the relationship between diversification, bank risk, and performance.
The author employs a comprehensive methodology to address the research questions by formulating hypotheses and utilizing experimental models for testing Specifically, for the first research question (RQ1), the author estimates relevant hypotheses through POLS, FEM, REM, and two-step SGMM, establishing RQ1 as the baseline model Detailed insights into the Quantile regression estimation can be found in section 3.3 of chapter 3.
To address the second research question (RQ2), the author employed the two-step SGMM method to estimate the experimental model for hypothesis testing The estimation spans the entire period from 2005 to 2019, incorporating a dummy variable to represent the financial distress period of 2011-2014, as outlined in section 2.5.5 Detailed information regarding the specific model and estimation methodology can be found in section 3.3 of chapter 3.
In addressing the third research question (RQ3), the author employs the two-step SGMM estimation method, incorporating interaction variables to examine the impact of ownership structure on the relationship between diversification strategies and banking risk and performance.
The research steps are expressed in figure 1.2 below.
Research contributions
This dissertation offers valuable insights for bankers and regulators by highlighting the empirical relationship between diversification strategies, bank risk, and performance, particularly during challenging times It aims to equip bank executives with evidence that supports informed strategic decision-making regarding operations, investments, and financing.
This dissertation offers valuable insights for policymakers in the banking sector, enhancing their understanding of the relationship between bank diversification and risk-performance By presenting empirical findings, it aims to equip government agencies with the necessary information to make informed decisions that improve banking practices and regulatory frameworks.
Research methodology and variables determination
Research data collection and processing
Variables descriptive statistics Analysis on cross-correlation matrix of variables
Multivariate regression with POLS, FEM, REM and two-step SGMM
This study conducts a robustness check to analyze how the ownership structure of banks—specifically state-owned banks, domestic private banks, and foreign banks—affects the relationship between diversification and bank risk and performance The findings indicate whether different ownership structures enhance or diminish the impact of diversification on these financial metrics.
In the literature, this dissertation fills up the following gaps:
Vietnam's banking market is an emerging and youthful sector with limited research on the relationship between diversification, risk, and performance This dissertation aims to enhance academic literature by exploring how diversification strategies—specifically in assets, income, and funding—affect bank risk and performance The ultimate objective is to identify the optimal model for integrating these diversification strategies to achieve superior banking outcomes.
There are still research gaps regarding the impact of financial distress on the relationship between diversification and risk-performance in banks This dissertation aims to fill those gaps by providing empirical findings that illustrate how diversification influences banks' risk and performance differently during periods of financial turmoil.
The ownership structure of banks significantly influences their risk and performance by affecting customer service, information access, and product offerings This study investigates how bank ownership impacts the relationship between diversification, risk, and performance, an area that has received limited attention in existing literature Our research aims to evaluate the connection between bank diversification and risk-performance, incorporating factors related to ownership structure We analyze state-owned and foreign-owned banks while considering macroeconomic conditions, industry-specific characteristics, and individual bank traits.
Structure of the dissertation
This dissertation comprises five chapters that examine the relationship between bank diversification, risk, and performance in Vietnam, particularly in the context of ownership strategies and financial turmoil Each chapter's abstract provides a comprehensive overview of the key findings and insights.
This chapter provides an overview of the dissertation, focusing on empirical research regarding the relationship between bank diversification strategies, risk, and performance It also examines the impacts of the banking crisis and the influence of bank ownership structures Key elements discussed include the research motivation and background, objectives and questions, scope and methodology, as well as the findings and contributions of the study, culminating in a summary of the dissertation.
The empirical findings reveal significant insights into the relationship between diversification strategies and their effects on bank risk and return across various types of banks, including state-owned, domestic private, and foreign banks Additionally, the analysis indicates that these results vary during the Vietnamese banking and financial distress period from 2011 onwards.
In 2014, the author presents key recommendations and policy implications for bankers and regulators based on research findings The insights from this dissertation also pave the way for future research developments.
Chapter 2: Literature review and hypotheses development
Chapter 2 offers a comprehensive examination of bank diversification, detailing its definitions, foundational theories, and various types It also evaluates empirical studies on bank performance and risk, outlining the relevant dependent, explanatory, control, and dummy variables Additionally, the chapter explores the interplay between diversification, ownership structure, bank risk, and returns during economic downturns, identifying gaps in existing literature and aiding in the formulation of research hypotheses Subsequently, Chapter 3 will employ diverse research methods to test these hypotheses.
This chapter outlines the empirical research design employed to test the hypotheses presented in Chapter 2, structured into four key sections It begins by detailing the data and sample utilized in the dissertation, including the study period and data-processing methods Next, the preliminary construction of the variables is addressed The methodology for measuring diversification, bank risk, and performance is then described Finally, the chapter concludes with a discussion of additional analyses and robustness checks for the chosen models.
Chapter 4 Empirical results and discussion
This chapter presents the regression findings from the econometric models in Chapter 3, examining how various diversification strategies and their interactions affect bank performance and risk, particularly during periods of banking distress and restructuring Additionally, it includes an analysis comparing results across different ownership types The author juxtaposes these regression outcomes with established hypotheses to address the initial research questions effectively.
Chapter 5 of the dissertation synthesizes the empirical findings from Chapters 3 and 4, revisiting the research questions while summarizing the methodology, hypotheses, and results It highlights the significance of the findings from various models and discusses their academic contributions and policy implications for stakeholders such as the State Bank of Vietnam and bank managers, aiding in strategic decision-making for sustainable development in the banking and financial sector The chapter concludes by addressing the study's limitations and offering recommendations for future research.
LITERATURE REVIEW AND HYPOTHESES
Bank diversification definition
Diversification is a widely studied concept across various fields, including corporate management, banking, finance, engineering, and biology Its meaning varies depending on the research context, leading to a need for a clear definition that is both theoretically and practically applicable Generally, diversification refers to the process of making things dissimilar Each discipline has tailored the concept of diversification to align with its unique characteristics, as evidenced by prior research in the respective industries.
The term “diversification” can be approached in 2 directions: (1) diversification in investment; and (2) diversification in operative activities.
Diversification is a strategic technique that involves allocating investments across various financial instruments to enhance performance and mitigate risks, as noted by A N Berger (1995) Additionally, Booz, Allen, and Hamilton (1985) emphasize that a company's diversity strategies are shaped by its objectives for growth, risk reduction, and establishing a robust business platform This approach is predominantly applied within the finance sector.
Organizations can enhance their performance and mitigate risks through diversification by expanding their product lines and entering new markets Diversification involves introducing new products or services, which is essential for companies seeking increased profits and growth (Ansoff, 1957) Additionally, firms can diversify by exploring new fields beyond their core business via self-development or mergers and acquisitions (Berry, 1971; Ramanujam & Varadarajan, 1989) The extent of diversification is determined by the revenue contributions from core, related, and unrelated products (Rumelt, 1974), each requiring distinct suppliers and logistics (Pitts, 1977; Pitts and Hopkins, 1982) Implementing a diversity strategy often necessitates adjustments in business plans, customer models, and technology applications (Kenny, 2009).
In both approaches, diversification seems to be considered a means and method to improve a firm’s performance and eliminate risks (Hoskisson & Hitt, 1990; H.Markowitz, 1952).
In the banking sector, diversification is essential for creating competitive advantages and enhancing profitability This can be achieved through the development of differentiated products and services, as well as geographical expansion Research indicates that banks often employ both product and geographical diversification strategies, which include introducing new services in areas such as banking, securities trading, and insurance By expanding their activities, assets, or liabilities, bank managers can effectively implement diversification strategies to boost income and profits.
In this dissertation, banking diversification is defined as the strategic integration of various activities aimed at diversifying income, assets, and liabilities, which ultimately helps in managing risk and enhancing the overall performance of bank operations.
Classification of bank diversification strategies
Previous studies have explored diversification through various dimensions, including deposit versus non-deposit, asset categories, and multi-industry approaches (A N Berger, Hasan, & Zhou, 2010) Other dimensions include revenue or income diversification (Gambacorta, Scatigna, & Yang, 2014; Kiweu, 2012), as well as product, service, and activity diversification (Mercieca et al., 2007), and geographical or international diversification (Lin, 2010) For instance, Liang and Rhoades (1991) identify three methods for banks to diversify: credit, stock investments, and holding Central Bank funds While Ebrahim and Hasan (2008) categorize these methods as product diversification, Kiweu (2012) refers to them as income diversification, highlighting the overlapping interpretations in the literature.
In their 1991 study, researchers highlighted that banks can enhance their strategies by integrating credit portfolios with geographic diversification Additionally, Saksonova and Solovjova (2011) proposed two primary methods for banks to achieve diversification: through the diversification of loan portfolios and investments.
Business diversification has evolved significantly since Rumelt's (1974) seminal research, which categorized it into four types: (i) Single Business, where enterprises concentrate resources on one area; (ii) Dominant Business, where firms expand into new areas while primarily focusing on their core operations; (iii) Related Business or related diversification, which involves expanding into areas closely linked to the core business; and (iv) Unrelated Business or unrelated diversification, where companies operate in entirely different sectors While various authors have adopted similar classification methods, Knecht's (2009) framework offers a broader perspective, identifying three main forms of diversification: (i) Related and unrelated diversification; (ii) Horizontal, vertical, and conglomerate diversification; and (iii) Domestic and international diversification Furthermore, this research categorizes geographical or international diversification based on geography and links horizontal and vertical diversification to the value chain contributions they provide.
Diversification in the banking sector is a topic with various perspectives, and one of the most recognized classifications is by Mercieca et al (2007), which outlines three dimensions of diversification: (1) the diversification of financial products and services.
(2) geographic diversification, and (3) a combination of geographic and business line diversification
Diversification of financial products and services is a strategic approach employed by banks to create new offerings and enhance existing ones to better satisfy customer needs According to Galbraith (2008), there are three types of product diversification: related, linked, and unrelated Related diversification involves introducing new business activities closely associated with current operations, such as manufacturing and marketing, to strengthen production processes Linked diversification focuses on leveraging shared resources and competencies across different industries, potentially creating sustainable competitive advantages, although it may not always align with the organization's strategic objectives Unrelated diversification occurs when businesses invest in entirely new and profitable industries that do not connect with their existing operations, providing a buffer during economic downturns and promoting growth in stagnant markets Overall, introducing new products can enhance competitiveness and stabilize seasonal sales.
Diversification techniques provide banks with significant advantages by promoting the development of non-credit services and new offerings for customers This approach helps mitigate risks, boost income, and reduce operating costs As many banks face bankruptcy due to debt recovery issues, the current trend is for banks to enhance their competitive advantages and ensure the sustainable stability of their core activities by selecting the most effective diversification methods.
Geographical diversification, often referred to as international diversification, encompasses two primary research avenues The first focuses on understanding diversification through the lens of individual countries, known as country diversification.
Bracker, 1989; Lu & Beamish, 2004), which means that businesses will consider each country's corresponding to each different market The second direction is regional diversification.
In today's globalized economy, international diversification has become essential for commercial banks, allowing them to expand their operations by opening branches or subsidiaries in new regions, often outside their home country This process involves careful feasibility assessments, including changes in corporate strategy and financial investments (Goetz, Laeven, & Levine, 2013; Liang & Rhoades, 1991) Geographic diversification enables banks to spread their activities and assets across various locations, aiming to increase market share, attract more customers, and mitigate specific risks associated with individual countries (Lin, 2010) Researchers often analyze this diversification through dummy variables or by measuring the ratio of foreign branch or subsidiary assets to total bank assets (Ugwuanyi et al., 2012; Lin, 2010).
Combining geographic and product diversification is the most effective strategy for enhancing business efficiency in banks By expanding their international operations and introducing a wider range of products and services in each new market, banks can better meet diverse customer needs, including money transfers, loans, and additional financial services (Brighi & Venturelli, 2016).
Geographical and product diversification assessments necessitate primary data, which is often inaccessible and inconsistent with the secondary data derived from audited financial reports of the selected banks in this dissertation.
Banking product or sectoral diversification, also known as industrial or business-line diversification, involves loans and net impairments in both mortgage and non-mortgage lending portfolios (D’Souza & Lai, 2003) In Vietnam, banks offer similar products and primarily focus on expanding their domestic branch networks, with only a few venturing into international markets due to capital constraints Overall, both product and geographic diversification in Vietnam remain relatively stable over time and do not significantly impact bank performance.
This dissertation will examine the elements of bank diversification, focusing specifically on business diversification, by utilizing Knecht's (2013) classification The study will analyze three key types of bank diversification: asset diversification, income diversification, and funding diversification, as illustrated by notable trends in these three diversification indices shown in Figure 1.1.
2.2.1 Asset diversification in the banking sector
The financial crisis highlighted significant weaknesses in banking business models, particularly evident in bank assets, leading to the exclusion of several major US investment banks from the market Notable events included Lehman Brothers' bankruptcy, Bear Stearns' merger with JP Morgan Chase, Bank of America's acquisition of Merrill Lynch, and the transformation of JP Morgan and Goldman Sachs into commercial banks This evolution illustrates the US banking sector's journey from the distinct separation of commercial and investment banking under the Glass-Steagall Act of 1933 to the establishment of a universal banking system with the Gramm-Leach-Bliley Act in 1999, culminating in the collapse of large independent investment banks during the 2008 crisis.
The global debate on the advantages and disadvantages of diversifying bank assets has shaped various permissible banking activities In light of recent crisis shocks, the swift resurgence of the universal banking model has prompted policymakers to view the integration of diverse services, such as universal banking and banc-assurance, as the most effective banking structure today.
Measurement of asset diversification levels in the banking sector
Asset diversification, as defined by L Laeven and Levine (2007), refers to the ratio of non-loan assets—such as underwritten securities and investments—to total earning assets This concept is quantified using a specific formula to measure asset diversification (AD).
In recent researches, Curi et al (2015); Elsas et al (2010); T L A Nguyen
Theories of bank diversification
The theory of financial diversification has been a central topic in economic studies, examining whether it enhances or diminishes firm value Research typically stems from two primary perspectives: finance and strategy From a financial standpoint, diversification can reduce certain risks, but higher management costs may make it less appealing for businesses compared to individual investors who diversify their portfolios at lower costs Conversely, the strategic view emphasizes that business diversification is crucial for entering new markets and launching products, thereby bolstering market power and enhancing competitive advantages that ultimately increase enterprise value.
Diversification strategies are generally more beneficial for businesses as they help mitigate unsystematic risks by spreading investments across various areas, aligning with the adage "don't put all your eggs in one basket" (Fama, 1985) On the other hand, concentration strategies can be advantageous for minimizing agency problems and leveraging specialized expertise and competitive skills, encapsulated in the saying "put all your eggs in one basket, and watch that basket" (Winton, 1999; P G Berger & Ofek, 1995; Jensen, 1986).
Firms diversify to enhance market power, address agency problems, and leverage their resource bundles for competitive advantage, as outlined by Montgomery (1994) This approach is rooted in market power theory, agency theory, and resource-based view theory, which emphasize profit maximization as a key driver of diversification Additionally, modern portfolio theory advocates for diversification as a strategy to mitigate risk in portfolio management.
According to Porter (1980), companies can effectively position themselves in the market by implementing strategies that differentiate them from competitors One such strategy is diversification, which serves as a means to navigate competitive landscapes (Barney).
In 1991, it was highlighted that companies can enhance their market power by diversifying into new markets, thereby gaining access to aggregated strengths By establishing a strong position in their core market, businesses can leverage their competitive advantages to expand into emerging areas, ultimately increasing their influence across multiple industries This foundational strength allows companies to adopt predatory strategies in new markets, supported by their existing resources and market position.
Companies can attain market power through diversification in three key ways Firstly, they can leverage profits from one market to subsidize pricing in another, a strategy known as cross-subsidization Secondly, maintaining mutual tolerance among competitors can help manage intense competition Lastly, establishing a cross-sector internal network allows subsidiaries to purchase from one another, enabling companies to effectively navigate and mitigate smaller competitive pressures.
(1994) The same conclusions were confirmed by Palich, Cardinal, and Miller
Market power held by conglomerates enables companies to manipulate market prices through strategies such as discounts, cross-subsidization, and reciprocal buying and selling, effectively deterring potential competitors from entering the market This competitive edge allows these companies to achieve higher profits than the average market rate Consequently, the theory of market power suggests that a diversification strategy serves as a robust mechanism for enhancing a company's financial performance and increasing profitability.
Agency theory highlights the conflict of interest between company owners and managers, leading to implicit costs known as agency costs These costs arise from the need to incentivize and monitor managers to align their actions with the owners' objectives, which may limit owners' decision-making for profit maximization Additionally, agency costs can manifest as a reduction in welfare or residual losses experienced by owners due to misaligned managerial decisions Managers may prioritize personal benefits over overall business profitability, exacerbated by differing risk tolerances between owners and managers Typically, owners focus on systemic risk, while managers often consider unsystematic risk, a discrepancy that becomes more pronounced in companies with significant free cash flow, where management tends to favor reinvesting retained earnings over distributing dividends.
Diversification is usually seen as a solution for managers (Jensen & Meckling,
According to Jensen (1986), managers with free cash flow often seek to consolidate their positions by expanding into low-profit areas, which can lead to value destruction and increased agency costs for the company This behavior is driven by a desire to enhance management capabilities and mitigate overall business risk, as noted by Montgomery (1994) Agency theory highlights that the benefits gained by managers can translate into costs for shareholders, suggesting that such diversification decisions may adversely impact the company's profitability.
Resources Based View (RBV) Theory
The Resources Based View (RBV) theory has been developed in many previous studies, such as that of (Barney, 1991; Teece, Pisano, & Shuen, 1997; Wernerfelt,
The Resource-Based View (RBV) theory, introduced by Edith Penrose in 1959 and later developed by Rubin in 1973, posits that companies engage in deliberate managerial strategies to attain sustainable competitive advantages This theory emphasizes that each organization possesses and utilizes a unique set of resources, making it a crucial framework for researchers examining the dynamics of competitive advantage.
The Resource-Based View (RBV) emphasizes how companies leverage their unique resources to achieve sustainable competitive advantages and enhance long-term performance, as outlined by Porter's five competitive forces Limitations in resource positioning enable some firms to maintain advantages that others cannot replicate, creating barriers to entry for new competitors This is further supported by the notion that firms with superior resource access can outperform rivals, as highlighted by Montgomery (1994) Prahalad and Hamel (1996) suggest that successful companies possess distinctive core capabilities that contribute to their sustainable advantage RBV also advocates for strategic diversification into new markets based on resource capacity, allowing firms to share costs and achieve economies of scale through related activities (Barney, 1991) By adopting an operational strategy that emphasizes resource allocation and core competency sharing across different business areas, companies can improve overall performance, reduce costs, and effectively eliminate competition.
The Resource-Based View (RBV) suggests that companies can achieve sustainable competitive advantages and reduce costs through the sharing of functions, resources, and skills This strategic approach is expected to enhance profitability, indicating a positive relationship between diversification and a company's financial performance (Mulwa, Tarus, & Kosgei, 2015).
Diversification plays a crucial role in modern investment theories, helping investors mitigate specific risks associated with their portfolios Familiar to most financial investors, the principle of diversification aligns with the adage "do not put all your eggs in one basket" (Fama & Jensen, 1985) By constructing a portfolio that encompasses various investments, investors can lower their overall risk For instance, relying solely on shares from one company exposes an investor to significant losses if that company's stock declines Conversely, spreading investments across different firms and markets can effectively reduce portfolio risk (Winton, 1999) Furthermore, diversification enables firms to allocate resources across multiple sectors, which can help cushion against potential failures (Haugen, 2001).
The theory of bank diversification is rooted in financial diversification principles and strategic cost-benefit analysis Bank managers may opt for diversification for several reasons, including the pursuit of synergy, advancements in portfolio theory, increased market power, and management-driven agency motives Key factors influencing a bank's decision to diversify encompass competition, interest expenses, banking technology, market share, default risk, and macroeconomic conditions, as noted by M Nguyen, Skully, and Perera (2012) A comprehensive understanding of bank diversification requires consideration of both managerial motivations and normative benefits.
The rapid introduction of innovative financial services and the strategic cross-selling of diverse financial products alongside traditional lending options present a substantial opportunity for enhancing the bank's revenue streams.
Concept and measurement of bank risk and performance
2.4.1 Concept and measurement of bank risk
Bank risk is a complex concept that encompasses various dimensions and approaches It refers to the potential loss of assets or a decline in actual profits compared to expected profits, as well as unexpected uncertainties that can negatively impact a business's operations and growth In the banking sector, understanding risk is crucial for accurately assessing a bank's profitability and cost efficiency Ignoring risk in estimation models can result in significant inaccuracies, hindering the ability to implement effective policies for optimizing bank operations and capital structure.
This dissertation evaluates the impact of diversification strategies on bank risk using five key risk indicators As the research encompasses both listed and unlisted banks, market risk is excluded from consideration The methodology for measuring these five risk indicators is detailed in the study.
The ZSCORE model, developed by Altman in 1968, is a statistical tool used for forecasting bankruptcy risk through a five-factor analysis This model employs multivariate discriminant analysis to assess a company's likelihood of failure based on its ZScore, achieving a 95% accuracy rate in predicting failures within one year However, its predictive accuracy diminishes over time, with rates dropping to 72% for two years, 48% for three years, 29% for four years, and 36% for five years or more prior to failure.
The term "failure" encompasses not only bankruptcy or insolvency but also refers to a company's inability to meet its financial obligations Following Altman's research, there has been a surge in interest regarding bankruptcy risk analysis, leading to the development of more sophisticated models to assess this risk Many of these studies concentrate on the banking and financial sectors, particularly from the 1970s onward A review of the bank risk literature reveals that the ZScore is widely recognized as a key risk indicator and a predictive tool for bankruptcy (Adusei, 2015; Andries).
& Capraru, 2013; Čihák, 2007; Diaconu & Oanea, 2014; Eisenbach, Keister, McAndrews, & Yorulmazer, 2014; Fiordelisi, Marques-Ibanez, & Molyneux, 2011; Groeneveld & de Vries, 2009; Lepetit, Nys, Rous, & Tarazi, 2008; Mercieca et al., 2007; Miklaszewska, Mikolajczyk, & Pawlowska, 2012; Petrovska & Mihajlovska, 2013).
Due to difficulty in the calculation when applying the Z - Score model measuring bank stability, Mercieca et al (2007) proposed the ZSCORE estimation equation with the following estimating factors:
Where: ROA is Return on assets, E/TA: Equity / Assets ratio, ℴROA: The standard deviation of ROA.
ZSCORE connects a bank's capitalization to its return on assets (ROA) and the risk associated with the volatility of its returns It measures how many standard deviations a bank's asset returns can decline before insolvency occurs Therefore, a higher ZSCORE indicates greater safety for the bank.
Because of the Basel treaty, banks should be more focused on managing their capital to avoid the risk of default A N Berger and Di Patti (2006), developing a
A strong credit model emphasizes the significance of equity in banks engaged in competitive credit operations, where a higher equity to asset ratio indicates better capitalization This relationship suggests that a higher equity to asset ratio reduces the risk of bankruptcy for banks.
In addition to the ZSCORE model widely used in most studies related to bank risk, Segoviano and Goodhart (2009) presented a method to measure banks' risk.
This report introduces methods for evaluating the risk of linear and non-linear banks in relation to fluctuations in the banking system throughout economic cycles The approach focuses on assessing the risk specific to each bank by analyzing the impact of economic changes, utilizing two key indicators: the Joint Probability of Distress (JPoD), which indicates the likelihood of all banks in a portfolio facing distress, and the Banking Risk Index (BSI), which estimates the expected number of banks that may become distressed Consequently, an increase in the number of distressed banks signifies a heightened risk within the banking system.
The ZSCORE model developed by Mercieca et al (2007) is widely recognized as an effective method for measuring bank risk, making it increasingly relevant to the unique characteristics of banking systems across various countries.
In addition to Z-core, contemporary research frequently employs various indicators to assess bank risk, including Risk-adjusted returns on assets (RAROA), Risk-adjusted returns on equity (RAROE), Standard deviation of Return on assets (SDROA), and Standard deviation of Return on equity (SDROE) (Edirisuriya, Gunasekarage, & Dempsey, 2015; C.-C Lee, Hsieh, & Yang, 2014; Meslier et al., 2014; Moudud-Ul-Huq et al., 2018) These risk measurement indicators are calculated using straightforward methods.
2.4.2 Concept and measurement of bank performance
According to Berger and Mester (1997), the performance of commercial banks is determined by the efficiency of converting input resources into output revenue The most successful banks are those that generate the highest revenue while utilizing the least amount of input resources.
Operational efficiency in commercial banks can be analyzed through three key approaches: first, minimizing costs by utilizing fewer input resources such as capital, facilities, and labor to maintain output levels; second, maintaining the same inputs while increasing output; and third, employing additional inputs that lead to a faster growth in output compared to input growth This study defines effective commercial banks as those that achieve the highest revenue output while utilizing the same input resources as their peers, all while incurring the lowest associated costs.
Up to now, there are two widely used measures of bank performance: structural approaches and non-structural approaches (Hughes & Mester, 2008).
The non-structural approach to assessing banking performance is the most widely used method, relying on key financial indicators such as return on equity, return on assets, return on sale, and cost ratio Additional metrics include Tobin's q index, which compares the market value of assets to their book value, the Sharpe index that evaluates return per unit of risk, and the capital adequacy ratio (Hughes & Mester, 2008).
As for the structural approach, researchers will rely on the cost, revenue, and (or) profit functions to analyze banking performance (Hughes & Mester, 2008).
This study evaluates bank performance using a nonstructural approach, focusing on two widely recognized indicators: Return on Assets (ROA) and Return on Equity (ROE) These metrics have been extensively utilized in prior research (Edirisuriya, Gunasekarage, & Dempsey, 2015; C.-C Lee, Hsieh, & Yang, 2014; Meslier et al., 2014; Moudud-Ul-Huq et al., 2018) The methodology for calculating these indicators is detailed below.
Theoretical overview of banking crisis
A banking crisis is triggered when central banks and financial authorities identify a specific shock that threatens the stability of the entire financial system (G Caprio & Klingebiel, 1996; Ergungor & Thomson, 2005) Two key central bank policies are closely associated with such crises Firstly, a bank run can result in the closure, merger, or public sector takeover of one or more financial institutions Secondly, in the absence of bank runs, the closure, merger, or substantial government support of large financial institutions can initiate a domino effect, leading to similar outcomes for other banks (Kaminsky & Reinhart).
Gonzalez-Hermosillo, Pazarbaşioğlu, and Billings (1997) identify banking crises through the intervention policies of central banks Subsequently, Bagatiuk (2009) characterizes a bank in crisis as one with a revoked license or under special oversight from the central bank or debt management agency This definition is widely accepted in academic research regarding banking crises.
Numerous researchers, including Kibritoglu (2003) and Von Hagen and Ho (2007), have attempted to quantify banking crises using technical indicators, with one prominent measure being the money market pressure index, which reflects central banks' actions prior to a crisis A significant rise in alarming debt levels or ongoing bank runs leads to a notable decline in commercial banks' liquidity In response, central banks typically increase required reserves to address the liquidity needs of these banks while also adjusting short-term interest rates to ensure the system's temporary liquidity.
The banking debt crisis in Vietnam
Dziobek and Pazarbasioglu (1998) and Hawkins and Turner (1999) identified 13 types of government responses to financial crises in their surveys of developed and developing markets Notably, the banking crisis in Vietnam from 2011 to 2014 exemplified four specific crisis management policies Firstly, the Vietnamese government and central bank implemented liquidity interventions, designating any bank receiving over 50% of its capital as a crisis bank Secondly, a nonperforming-loan management unit was established, requiring banks with nonperforming loans exceeding 3% to restructure by selling these debts to the Vietnam Asset Management Company (VAMC), which was initiated in 2013 The third response involved the State Bank of Vietnam or a third party taking over full or partial ownership of struggling banks Lastly, the consolidation of crisis banks was promoted, merging strong and weak banks to enhance overall system efficiency, improve management quality, and leverage advanced technology to address nonperforming loans.
In 2012, the State Bank of Vietnam implemented a restructuring process to address sub-prime debt issues, resulting in restrictions on nine banks, including Navibank, Trust Bank, and Western Bank Mergers and acquisitions emerged as the primary solution, notably leading to the formation of Saigon Commercial Bank (SCB) from the merger of Ficombank, Tin Nghia Bank, and Saigon Bank in December 2011 Additionally, Habubank merged with Saigon Hanoi Bank (SHB) in August 2012 By the end of 2014, the number of operational banks in Vietnam decreased to 35, down from 42 in 2011.
Previous studies on banking crisis theories highlight key determinants that require further investigation in the context of Vietnam, with bank capital emerging as a crucial factor influencing the stability of the banking system (Demirguc-Kunt, Detragiache, & Merrouche, 2013; Morrison & White).
Asset quality is a critical determinant of a bank's balance sheet, with non-performing loans (NPLs) serving as a key indicator of this quality; higher NPLs suggest poorer bank performance Additionally, sustainable high income is vital for enhancing a bank's capital and economic viability, reducing the likelihood of failure Furthermore, the ownership structure plays a significant role in assessing the overall health of the banking system.
A pertinent question emerges regarding the level of non-performing loans (NPLs) that could trigger a financial crisis While determining a definitive answer is challenging, research often identifies a threshold of 10% as a critical point for indicating a potential crisis.
Between 2011 and 2014, Vietnam faced a significant banking crisis, with non-performing loans (NPLs) estimated at 10-15% of total loans, more than double the central bank's reported figures This period, characterized by financial distress, is highlighted in a study by G Caprio and Klingebiel (1996) and supported by Moody’s Investors Services The recovery of the Vietnamese banking system began in 2016 with the implementation of Basel II regulations mandated by the State Bank.
The impact of diversification on bank risk and performance
Although the concern on the impact of diversification on banks' risks and performance is discussed in various articles, the conclusion of this topic is still unclear.
Supporters of diversity in banking highlight several key theories, including economies of scale, tax advantages, market power, capital structure, and co-insurance effects Notably, Diamond (1984) emphasizes the economies of scale theory, arguing that banks can leverage their existing infrastructure to offer a wider range of services to customers Additionally, Drucker and Puri (2005) observe that diversified banks experience a decrease in cost per unit, further supporting the benefits of diversification in the banking sector.
Numerous studies highlight the tax advantages associated with diversification strategies, noting that balancing profits and losses across various banking activities or intra-firm transactions can yield significant tax benefits (Majd & Myers, 1987; Palich et al., 2000).
Diversification plays a crucial role in stabilizing the banking capital structure by allowing banks to utilize profits from various segments to manage debts without adversely affecting their overall financial health This strategy can enable banks to adopt competitive pricing tactics to outmaneuver rivals (Palich et al., 2000) Additionally, banks that implement diversification strategies often benefit from lower funding costs due to enhanced cash flow flexibility (Meyer, Milgrom, & Roberts, 1992) Research by Penas and Unal (2004) indicates a notable reduction in funding costs following bank mergers between 1991 and 1998 Furthermore, mergers and acquisitions with insurance companies or ventures into non-traditional banking sectors can help banks mitigate failure risks (Boyd, Graham, & Hewitt, 1993; Rose, 1989).
D'Souza and Lai (2002) found no significant evidence linking sector diversification to bank profitability, nor did bank size affect performance However, they noted that diversifying banking portfolios and business lines can have historical significance While the authors observed no substantial effects of scale in bank mergers, they acknowledged the importance of economies of scale, suggesting that merging banks and similar business lines can lead to the creation of a more powerful entity.
To assess the impact of mergers and acquisitions on the performance of financial institutions, we focus on the changes in portfolio composition resulting from such mergers This aligns with the findings of D'Souza and Lai (2002), who examined how a merger between two banks influences the portfolio financing decisions of the newly merged entity, as well as its effects on the efficiency of bank-based financial markets.
Boyd and Prescott (1986) advocate for extensive diversification in banking based on the delegated supervision approach, suggesting it as the optimal structure In contrast, Acharya, Saunders, and Hasan (2002) caution that diversification may incur drawbacks or implicit costs for certain banks These costs can stem from insufficient managerial supervision and control, as well as an increased risk in loan portfolios when banks invest in highly competitive sectors where they lack adequate experience.
Research by DeLong (2001) indicates that geographical diversification offers banks significant economic advantages alongside certain risks By expanding into various countries, banks can tap into multiple capital markets, enhancing their brand recognition and market share This expansion not only boosts scale efficiency but also helps in cost reduction Additionally, establishing branches in tax havens like Panama or the British Kingdom can provide tax benefits However, banks must also consider potential drawbacks, including investment costs, labor expenses, training, exchange rate fluctuations, political risks, and local legal restrictions Ultimately, despite these challenges, geographical diversification remains a favored strategy for banks aiming to broaden their business and enhance their market presence.
2.6.1 Asset diversification, bank risk, and performance
Asset diversification and bank risk
Diversification plays a crucial role in reducing bank risk, as highlighted in various empirical studies that examine the relationship between income from different activities Researchers, including Kashyap and Stein (1995), have explored how diversification can serve as a preventive measure against banking issues Contrary to traditional portfolio theory, some scholars, such as Tabak et al (2011), advocate for banks to diversify their loan portfolios to mitigate credit risk, with findings indicating that reduced credit concentration can enhance stability The Basel Committee on Banking Supervision (1991) noted that many banking crises over the past thirty years were linked to concentration, underscoring the importance of diversification in risk management Supporting evidence from studies conducted in Argentina and Austria further reinforces this perspective (Bebczuk & Galindo, 2008; Rossi et al., 2009).
Research indicates that banks focusing their lending on specific sectors tend to experience lower credit risk compared to the overall banking system Studies show that these specialized banks often have a reduced standard deviation in credit loss, suggesting that concentration in lending can lead to more stable credit performance (Hsieh et al., 2013; Jahn et al., 2013; C.-C Lee et al., 2014; Rossi et al., 2009).
Some researchers argue that asset diversification does not necessarily enhance banks' security, with insufficient evidence supporting this connection (Acharya et al., 2006) Currently, banks are increasingly engaging in riskier industries, which diminishes the advantages of diversification (Stiroh, 2015) Stiroh also notes that internal risk-taking is often driven by managers' incentives to pursue riskier assets for higher profits, creating ambiguity in the relationship between diversification and banking risk Additionally, Boot and Ratnovski (2016) introduced a model indicating that the interplay between long-term relationship banking and short-term transactional banking can adversely affect the former, resulting in limited risk benefits from diversification.
Asset diversification and bank performance
Research indicates that diversification positively influences bank performance and efficiency Banks are unique institutions that excel in gathering and utilizing customer information, which supports the argument for diversification as a strategic advantage for financial intermediaries By diversifying, banks can enhance the quality of their income through improved intermediation and reduced information asymmetries Additionally, diversification fosters competition and drives financial innovation within the sector.
Moreover, diversification allows credit institutions to benefit from cheaper monitoring, greater efficiencies, and more effective management skills (Drucker
Research conducted in six Asian countries indicates that banks with a higher level of foreign-owned asset diversification tend to exhibit greater profit efficiency (Puri, 2009; Iskandar-Datta & McLaughlin, 2007; Moudud-Ul-Huq et al., 2018; Tabak et al., 2011).
L A Nguyen, 2018) In addition, it is suggested that asset diversification has a positive impact on banks' long-term performance (Baele et al., 2007).
Several studies indicate that diversification negatively impacts bank performance, advocating for a focused strategy Corporate finance theory suggests that firms benefit from reduced costs by concentrating on sectors where they possess expertise (Acharya et al., 2006) A concentration strategy can help eliminate agency issues and leverage management expertise (Berger & Ofek, 1995; Jensen, 1986) Additionally, some firms are reluctant to pursue diversification due to increased competition (Winton, 1999) Research across various banking sectors, including Italy, Germany, Brazil, and small European banks, supports this perspective (Acharya et al., 2006; Mercieca et al., 2007) Elyasiani and Wang (2012) highlight a negative correlation between asset diversification and the technical efficiency of foreign banks in financial centers Similarly, Berger, Hasan, and Zhou (2010) find that product diversification in Chinese banking results in higher costs and lower profits, while Laeven and Levine (2007) report significant negative excess values associated with diversification Although asset diversification may reduce bank performance, controlling for screening and monitoring capabilities can diminish or nullify this effect (Vazquez & Federico, 2015).
Research on the relationship between asset diversification and bank performance has yielded mixed results, with some studies finding no significant correlation (Hsieh et al., 2013) Others, like Maudos (2017), suggest that the positive impact of diversification on profitability is not universally applicable, as its effects can vary by institution and diversification approach Consequently, previous studies have produced inconsistent conclusions, with even similar research by the same author showing different outcomes (A N Berger et al., 2010) It is argued that the relationship between bank performance and diversification strategy is complex; rather than simply favoring diversification or concentration, the effectiveness of a bank's operational management of its diversification strategy is crucial for determining future profitability.
Furthermore, the researcher also found that asset diversification only helps banks grow instantly, but lacks long-term efficiency (T L A Nguyen, 2018) Curi et al.
Asset diversification positively impacts bank performance primarily during consolidation periods, rather than during crises This finding aligns with earlier research on U.S banks and a global sample analyzed until 2008, which indicates that the benefits of asset diversification do not consistently persist over time Although a positive correlation exists between asset diversification and banking performance before crises, this relationship lacks statistical significance during economic downturns Consequently, variations in profitability for foreign banks implementing asset diversification are evident in consolidation and pre-crisis periods, but not during crises, as no substantial evidence supports the influence of asset diversification on foreign bank performance in such times.
Summary
This chapter explores the relationship between diversification, bank risk, and performance, highlighting key theories in the literature, including Market Power Theory, Agency Theory, Resource-Based View Theory, and Modern Investment Portfolio Theory.
Based on the literature review in theoretical and empirical studies in previous sections, this dissertation builds the hypotheses to implement and answer the research objectives and questions (see Figure 2.1).
Source: Author’s calculationThe next chapter, Chapter 3 presents research data and methodology.
