Diversification Effects on the Banks’ Return and Risk

Abstract

This article analyses the diversification effects on the exchange listed EU banks’ risk-return framework. Second banking directive of 1989 has initiated the boom of activity diversification in Europe. The empirical results indicated to the statistically significant diversification premium on the banks’ performance, using the non-interest income share, together with its quadratic term, as indicator of banking diversification. The same holds for the banks with the diversified assets. In terms of revenue diversification, diversified banks are less profitable. Due to the statistically insignificant outcomes, in case of total and bank-specific risk analysis, it is difficult to make an implicit conclusion, how the diversification decision affects those types of risk. But, in terms of systematic risk there is strong statistical evidence that more diversified banks are exposed to higher levels of market risk. As a result, for the sample of European banks, the positive risk-return trade-off was not found.