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Loan portfolio diversification and bank returns: Do business models and market power matter?

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  • Japan Huynh
  • Van Dan Dang
  • David McMillan

Abstract

The paper examines how loan portfolio diversification drives bank returns, mainly focusing on the conditioning roles of business models and market power in this nexus. We employ a sample of Vietnamese commercial banks from 2008 to 2019 to perform regressions in the dynamic panel models with the two-step system generalized method of moments (GMM) estimator. We find that increased sectoral loan portfolio diversification reduces bank returns, but not all banks are equally affected. Banks that adopted a business model towards non-interest activities are hurt less from loan portfolio diversification, and bank market power may mitigate the detrimental effects of loan portfolio diversification on bank returns. When such asymmetric effects are sizeable, neglecting them could miscalculate the choice of loan portfolio diversification. Our findings are robust to a rich set of bank return indicators and alternative loan portfolio diversification measures based on the Herfindahl-Hirschman (HHI)/Shannon Entropy (SE) indexes with different sectoral exposure profiles. Thus, both regulators and commercial banks should take the disadvantage of portfolio diversification into account when encouraging/pursuing a diversified strategy, which must be accompanied by the crucial caveat that the damage is most pronounced for banks with lower shares of non-interest income and less market power.

Suggested Citation

  • Japan Huynh & Van Dan Dang & David McMillan, 2021. "Loan portfolio diversification and bank returns: Do business models and market power matter?," Cogent Economics & Finance, Taylor & Francis Journals, vol. 9(1), pages 1891709-189, January.
    • Handle: RePEc:taf:oaefxx:v:9:y:2021:i:1:p:1891709
    DOI: 10.1080/23322039.2021.1891709
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    Citations

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    Cited by:

    1. Marco Cucculelli & Riccardo Cappelli & Jasmine Mondolo, 2024. "Does market power drive business model innovation? Evidence from Italian family manufacturing firms," Small Business Economics, Springer, vol. 63(1), pages 447-475, June.
    2. Khoa Dang Duong & Hoi Vu Le & Duy Nhat Vu & Ai Ngoc Nhan Le, 2023. "Do Bank Funding Diversity and Bank Lending Affect Net Interest Margins? Evidence From Asia Markets Before and During the Covid-19 Pandemic," SAGE Open, , vol. 13(4), pages 21582440231, December.
    3. Thich Nguyen & Chi Huu Lu, 2024. "Financial intermediation in banks and the key role of intellectual capital: new analysis from an emerging market," Journal of Financial Services Marketing, Palgrave Macmillan, vol. 29(2), pages 508-522, June.
    4. Šeho, Mirzet & Bacha, Obiyathulla Ismath & Smolo, Edib, 2024. "Bank financing diversification, market structure, and stability in a dual-banking system," Pacific-Basin Finance Journal, Elsevier, vol. 86(C).
    5. Cicchiello, Antonella Francesca & Cotugno, Matteo & Perdichizzi, Salvatore & Torluccio, Giuseppe, 2022. "Do capital buffers matter? Evidence from the stocks and flows of nonperforming loans," International Review of Financial Analysis, Elsevier, vol. 84(C).

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