Bank diversification, performance, and corporate governance: evidence from China

* Accepted by Hong Hwang upon recommendation by Desmond Tsang.

Abstract

This paper examines the merit of bank diversification using a sample of listed Chinese national banks during 2003–2012. We find that income source diversity positively affects profitability but negatively affects operating efficiency and market valuation. By exploiting an exogenous change in the regulatory attitude toward diversification in 2008, we find that the positive diversification-profitability relation before 2008 changes to negative afterwards; meanwhile, the diversification discount turns to premium. We conjecture that the source of discount captures changes in the diversification-induced agency costs. Finally, we find that governance matters as it enhances the positive diversification-profitability relation and mitigates diversification discount.

Keywords:

• Financial institutions
• corporate governance
• bank performance
• China

Disclosure statement

No potential conflict of interest was reported by the authors.

Funding

This work was supported by Ministry of Science and Technology, Taiwan [grant number 105-2410-H-035-008-].

Notes

* Accepted by Hong Hwang upon recommendation by Desmond Tsang.

1. For example, China conducted a dual-class share structure reform that allowed non-tradable shares to tradable shares in May 2005. Following the reform, Chinese firms have only one class of shares for all investors. In addition, China began allowing short selling and margin purchase in its stock markets on March 31, 2010.

2. OECD (2006) further points out the poor corporate governance of banks in Asia can further destabilize financial systems and worsen the systematic risk of fragile real economy in Asia.

4. Results are available upon request.

5. We shall examine in more detail of this conjecture in the last part of our analyses (‘Role of governance quality in the diversification-performance relation’).

6. Readers interested in this evolution are encouraged to refer to Berger, Hasan, and Zhou (2010) for a more detailed discussion.