Revenue diversification in emerging market banks: implications for financial performance

TL;DR

This study investigates how diversification into non-interest activities affects the financial performance of emerging market banks, revealing that benefits depend on bank-specific factors and risk management strategies.

Contribution

It provides empirical evidence on the complex, non-linear relationship between diversification and performance in emerging market banks post-1997 crisis.

Findings

Diversification increases exposure to trading income volatility.

The effect of diversification on performance is non-linear and varies among banks.

Proper risk management and niche selection are crucial for benefits.

Abstract

Shaped by structural forces of change, banking in emerging markets has recently experienced a decline in its traditional activities, leading banks to diversify into new business strategies. This paper examines whether the observed shift into non-interest based activities improves financial performance. Using a sample of 714 banks across 14 East-Asian and Latin-American countries over the post 1997-crisis changing structure, we find that diversification gains are more than offset by the cost of increased exposure to the non-interest income, specifically by the trading income volatility. But this diversification performance's effect is found to be no linear with risk, and significantly not uniform among banks and across business lines. An implication of these findings is that banking institutions can reap diversification benefits as long as they well-studied it depending on their specific characteristics, competences and risk levels, and as they choose the right niche.