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Net economic gain from diversification in the commercial banking industry

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  • Abdullah Al-Obaidan

Abstract

During the last two decades, banks have acquired new powers to expand the scope of their operations. Given these opportunities, the evolving structure of the banking industry will depend largely on the extent of product-mix efficiency available to commercial banks. Those banks that adopt the most efficient product mix are in a position to exploit the relative cost advantages and to continue to grow. This empirical study provides comprehensive measures of the economic impact of diversification in the commercial banking industry. Diversifying a bank's operation is not a costless endeavour. The empirical findings suggest, ceteris paribus, that while diversification reduces technical efficiency by approximately 28%, it improves allocative efficiency by 4% and increases scale efficiency by 39%. The overall economic gain from diversification in the commercial banking industry is approximately 1%. The optimal strategy of a commercial bank is to internalize market transactions to the margin where benefits are equal to cost. The empirical results suggest that this strategy is generally sustained in the commercial banking industry.

Suggested Citation

  • Abdullah Al-Obaidan, 1999. "Net economic gain from diversification in the commercial banking industry," Applied Financial Economics, Taylor & Francis Journals, vol. 9(4), pages 343-354.
    • Handle: RePEc:taf:apfiec:v:9:y:1999:i:4:p:343-354
    DOI: 10.1080/096031099332230
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    1. Neil M. Kay, 1982. "Strategy and Structure," Palgrave Macmillan Books, in: The Evolving Firm, chapter 8, pages 133-142, Palgrave Macmillan.
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    4. Jeffrey A. Clark, 1988. "Economies of scale and scope at depository financial institutions: a review of the literature," Economic Review, Federal Reserve Bank of Kansas City, vol. 73(Sep), pages 16-33.
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    1. Paltrinieri, Andrea & Dreassi, Alberto & Rossi, Simone & Khan, Ashraf, 2021. "Risk-adjusted profitability and stability of Islamic and conventional banks: Does revenue diversification matter?," Global Finance Journal, Elsevier, vol. 50(C).
    2. Mariarosa Borroni & Simone Rossi, 2017. "Does revenue diversification still matter in banking? Evidence from some European countries," DISCE - Quaderni del Dipartimento di Scienze Economiche e Sociali dises1723, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).

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