Risk and Performance in Emerging Economies: Do Bank Diversification and Financial Crisis Matter?

Abstract

This study empirically investigates the quadratic effects of bank diversification, size and global financial crisis on risk-taking behaviour and performance. To unfold those effects, it uses the generalized method of moments (GMM) estimator and also uses an unbalanced panel data set on a large sample consisting of 542 bank-year observations between 2004 and 2015. The key results for emerging economies are as follows: (a) increasingly higher non-performing loan ratio makes the bank underperforming and unstable; (b) benefits derived from bank diversification are heterogeneous and confirms portfolio diversification theory; (c) small-sized banks of Bangladesh ensure higher advantage from portfolio mix over large banks; (d) large banks of South Africa achieve higher benefit from income diversification over small-sized banks; and finally, this study evidences that during the financial crisis, emerging economies can use portfolio diversification as a mechanism for controlling risk and improve bank performance. Mainly, emerging countries can rely on income diversification and should involve this mechanism with systematic risk a great care of.