Bank diversification and systemic risk

Abstract

One of the controversies of diversification is that it may not be necessarily beneficial to the banks as it leads to more severe systemic risk. Recent studies have modelled theoretical frameworks for the role of diversification in systemic risks faced by banks. As an alternative, we provide empirical evidence on this by examining the effects of bank diversification on systemic risk. Based on the sources of revenue of banks to measure diversification and using data of U.S. commercial banks from 2000 to 2013, we find that the bank diversification is associated with an increase in systemic risk. However, such effect of diversification on systemic risk is significant in larger- and medium sized banks. The effects are also significant during the 2007–2009 credit crunch and 2010–2013 European Debt crisis, supporting the idea that bank diversification plays a crucial role to influence systemic risk.