How the banks diversify and how it affects their performance

Purpose The purpose of this study is to be motivated to empirically investigate how banks evolve and adapt to a rapidly changing business environment by exercising diversification. The second motivation of this study is to look at how the heterogeneity of the banking system across the economies affects their decision to diversify. Design/methodology/approach This study explicitly modeled the underlying risk when the bank exercises diversification. In this paper, they employ a dynamic generalized method of moments (GMM) model on association of southeast Asian nations (ASEAN) panel banking data. The authors’ observed 168 banks during the period 2010-2022 available on Bankfocus, with a total of 2,184 observations covering nine countries in ASEAN. Findings First, they find diversification negatively affects bank performance; second, conservatism helps to dampen the negative effect of diversification; third, diversification did dampen the negative impact of the credit risk; fourth, banks exercise diversification when their efficiency is low but resulting in lower performance. These findings urge the financial service authorities and the central banks in ASEAN to direct banking toward a more optimal diversification. Research limitations/implications Because of the chosen research approach, the research finds no empirical proof about the effect of liquidity preservation, the length of the time horizon to optimize and the interbank position, on the diversification activity of the banks in ASEAN. Practical implications The paper includes this, implying the strategy for developing the banking sector varies and is conditional for each country. Originality/value The major contribution of they study is that they explicitly model the underlying risk when a bank exercises a diversification strategy. In this study, they set performance as the objective of the bank and one way to achieve their performance target is to carefully consider risk when exercising a diversification strategy. They study formally internalizes these aspects of the model.