Diversification strategies in banking: Like lemmings falling off a cliff

This paper develops a theory of bank diversification across business segments and income streams. Motives for diversification include the alleged impact on performance, risk, and value; however, the theory also permits herd behavior. The paper tests four propositions using hand-collected business segment data of the top 100 banks from 1998 to 2010. The study distinguishes between retail, corporate, investment, and private banking and various income streams. Empirical evidence suggests that diversification enhanced performance but did not reduce risk. After the financial crisis, diversification contributed to risks. Diversification did not deliver economic value added and only moved banks closer to the efficient frontier in the pre-crisis period. These findings caution strategists against applying theories developed in finance to understanding business strategies in a different strategic space.