The choice between focus and diversification strategies in banking and its relationship to risk and return outcomes

This research examines whether the risk of financial institutions in six different focused peer groups is higher than that of banks in more diversified peer groups. It investigates whether the risk-reducing benefits of diversification outweigh the benefits of specialization. Each focused group includes banks with a large proportion of assets in a narrow industry segment such as agricultural loans, credit cards, commercial lending, mortgage lending, consumer lending and other focused loans.;This thesis differs from much of the research in this area in taking a regulator-focused approach rather than the perspective of a shareholder. Regulators differ from shareholders because they cannot diversify themselves to improve their risks. A better understanding of the relative levels of risks of different types of strategies and industry focuses could contribute to a better allocation of regulatory resources, and to more effective supervisory interventions.;This study differs from similar work in the past because it controls for the size and tax-status of the banks in the sample, and compares focused banks to a sample including only diversified banks. Other studies, in contrast, compared one focused peer group to a comparator group of all banks but for the one focused group. Thus, the comparator group included both diversified and focused banks. Further, this study includes six different focused groups of banks whereas most previous studies considered only one focused group. This study also considers banks that switch between focus and diversification strategies as a distinct class of banks and is therefore unique in this regard.;The data in this study confirm the major hypothesis that banks following a diversified strategy are less risky than banks following an industry-focused approach. It provides limited support for the hypothesis that diversified banks will generate lower returns on assets than focused banks, although this finding seems to be size-dependent and to apply only to certain focused groups. The third major hypothesis, that diversified banks will have lower standard deviations of returns on assets, is also supported. The results for the hypothesis that diversified banks will hold less capital relative to assets than focused banks, is largely contradicted.