Abstract
We collected data pertaining to Chinese listed commercial banks from 2008 to 2016 and found that the competition between banks is becoming increasingly fierce. Commercial banks have actively carried out diversification strategies for greater returns, and the financial reports show that profits are increasingly coming from the non-interest income benefits of diversification strategies. However, diversification comes with risk. We built a panel threshold model and investigated the effect of income diversification on a bank’s profitability and risk. Diversification was first measured by the Herfindahl–Hirschman index (HHI), and the results show that there is a nonlinear relationship between diversification and profitability or risk does exist. We introduced an interesting index based on the entropy to test the robustness of our model and found that a threshold effect exists in both our models, which is statistically significant. We believe the combination of the entropy index (ENTI) and the HHI enables more efficient study of the relationship between diversification and profitability or risk more efficiently. Bankers and their customers have increasingly been interested in income diversification, and they value risk as well. We suggest that banks of different sizes should adopt the corresponding diversification strategy to achieve sustainable development.
Highlights
Note that ***, **, and * indicate statistical significance at the 1%, 5%, and 10% levels, respectively; DIV_1 and DIV_2 represent the coefficient of income diversification when the bank size is smaller and larger than the threshold parameter, respectively; N and R2 refer to the number of observations in the sample and the statistics indicator, which reflects the goodness of fit
The regression of a bank’s profitability on diversification (Column 1) shows that, when the bank size is smaller than the threshold value of 10.33739 trillion RMB, income diversification negatively influences the return, measured by risk-adjusted return on assets (ROA), and the influence is significant at the 10% level
For the controlled variables, we find that bank size negatively affects the equity ratio and has a positive relationship with profitability, which implies that small banks may perform better than large banks
Summary
Since 2006, the reform of China’s banking industry has taken a new and important step. (CCB), Agricultural Bank of China Limited (ABC), and Bank of Communications Co., Ltd. The reform of interest rate marketization (IRM) has been steadily promoted. Zhou Xiaochuan, China’s central bank chief, pointed out that IRM enlarged the banks’ pricing power and the pricing power on loans and deposits. The reform will help the market play a role in allocating resources and reflect the independent pricing power of financial institutions on their products and services. In recent years, the Chinese government has emphasized the importance of promoting IRM reform in reports on the work of the government
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