Impact of Diversification on Bank Stability: Evidence from Emerging and Developing Countries

Abstract

As a result of the continual debate between portfolio optimization and the assumption of corporate strategy, it is debatable whether diversification enhances stability. This study examines the effect of diversification on bank stability by employing panel data representing 45 African nations between 2000 and 2020. Based on dynamic panel generalized moments techniques, the results support portfolio theory; diversification reduces risk and improves bank stability in emerging and developing economies during crisis and noncrisis periods. Bank diversification and stability have a quadratic association; overdiversification exposes banks to risk. The results also suggest that banks with a high interest margin, liquidity, and an increased cost‐to‐income ratio tend to become less stable. On the other hand, banks with higher leverage and operating in a country with country‐level solid corporate governance are more stable. GDP growth and inflation have a substantial influence on the financial health of banks. This research has significant repercussions for banks, policymakers, and academics aware of the impact of diversification on a bank’s risk and stability in emerging and developing markets.

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