How do income diversification, firm size and capital ratio affect performance? Evidence for bank holding companies

We use panel data from 52 Italian Bank Holding Companies (BHCs) over the period of 2006 to 2011 to test how revenue diversification affects bank performance. Unlike studies of diversification that focus on its effect on equity and debt values and risk return portfolio strategies, we investigate how various nontraditional revenues mix impact performance. Diversification increases bank profitability on a risk-adjusted basis; however, no statistical effect in terms of risk is observed. We also argue that the results of previous research on the impact of diversification may differ because of its interaction with asset size and degree of capitalization. Our models are robust to different measures of performance, endogeneity tests and the effect of the financial crisis. The results have strategic implications for the consequences of bank performance and stability that are relevant to bank managers, regulators and supervisors.