Does sectoral diversification of loans and financing improve bank returns and risk in dual-banking systems?

Abstract

This paper investigates the effects of sectoral diversification of loans and financing on the risk and the returns of banks in dual-banking systems. We employ the system GMM estimator on a unique panel data of 46 Islamic and 60 conventional banks from six countries over the period 2000–2015. Our findings reveal that sectoral diversification of loans and financing reduces the returns and increases the risk of both Islamic and conventional banks; the impact of sectoral diversification on returns varies across risk levels, with negative effects at low- and no effect at moderate- and high-risk levels; the difference between the impacts on Islamic and conventional banks across risk levels are marginal, and the adverse effects of sectoral diversification were exacerbated during the 2008 financial crisis. Expansion of loan and financing portfolios into new sectors has no impact on bank returns and risk in our sample. The findings may provide valuable implications for all stakeholders, regulators, and policymakers.