Bank Diversification and Risk Management

Project Start: 05/2014
Status: Completed
Researchers: Yangming Bao, Martin Götz, Dominic Hirschbühl, Luc Laeven, Ross Levine
Category: Financial Institutions

Topic and Objectives

Financial institutions exhibit a unique risk management possibility due to the combination of deposit taking and lending decisions. By supporting lines of credit via non-transaction deposits, banks can actively manage their exposure to liquidity risk. The project examines empirically whether and how the geographic diversification of banks affects their risk management possibilities. Greater geographic diversification, on the one hand, insulates banks from adverse shocks to lending if shocks across areas are not perfectly correlated. This decreases their exposure to liquidity risk. Raising deposits from different areas, on the other hand, exposes banks to idiosyncratic funding shocks, which limits their risk management possibilities. The team uses regulatory data on publicly traded bank holding companies (BHC) in the U.S. and information on the removal of interstate banking restrictions to identify the causal effect of geographic diversification on bank risk.

Key Findings

  • Greater diversification of US banking holding companies lowers risk. This effect is robust and not sensitive to alternative definitions of risk.
  • Furthermore, we find no evidence that greater geographic diversification leads to less loan quality.

Related Published Papers

Author/s Title Year Research Area Keywords
Martin Götz, Luc Laeven, Ross Levine Does the Geographic Expansion of Bank Assets Reduce Risk?
Journal of Financial Economics
2016 Financial Institutions Banking, Bank Regulation, Financial Stability, Risk, Hedging, Business Cycles, Industrial Structuree

 

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