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INTRODUCTION
Research motivation
In 1952, Nobel Laureate Harry Markowitz revealed that concentrating all investments in a single asset is highly risky, emphasizing the importance of diversification as a nearly risk-free strategy for investors and businesses His groundbreaking findings sparked a financial revolution that transformed Wall Street, corporate finance, and global business decision-making, with its impactful principles still influencing financial strategies today.
Diversification in the banking sector offers significant advantages, such as leveraging managerial skills across different products and regions (Iskandar-Datta & McLaughlin, 2007), exploiting economies of scale through shared fixed costs (Drucker & Puri, 2009), and providing a broad array of financial services to meet clients' diverse needs However, its impact on risk and performance remains a subject of debate, with conflicting arguments surrounding its overall effectiveness.
Diversified banks may face a reduction in their comparative management advantage when investing across many areas outside their expertise (Klein & Saidenberg, 1998) Additionally, diversification can intensify market competition (Winton, 1999) and lead to higher agency costs, as managers might reduce risk by engaging in value-diminishing activities (L Laeven & Levine, 2007).
The empirical literature on banking diversification first addresses developed markets, where banks have been fully mature, such as the US market and other
Research indicates that 13 developed European countries have been extensively studied in the context of financial stability and banking sector performance (Baele, De Jonghe, & Vander Vennet, 2007; Curi, Lozano-Vivas, & Zelenyuk, 2015; Elsas, Hackethal, & Holzhauser, 2010; Mercieca, Schaeck, & Wolfe, 2007; Stiroh & Rumble, 2006) Conversely, emerging and transition economies have also been the focus of research, highlighting different challenges and dynamics in these regions (N Chen, Liang, & Yu, 2018; Moudud-Ul-Huq, Ashraf, Gupta, & Zheng, 2018) The literature reveals varying results across countries and regions, emphasizing the importance of contextual factors in financial studies (T L A Nguyen, 2018) According to Doumpos, Gaganis, and Pasiouras, understanding these differences is crucial for developing targeted financial policies and strategies.
(2016), diversification can be more beneficial for banks operating in less developed countries compared to banks in advanced and major advanced countries.
Vietnam is among the fastest-growing emerging markets, undergoing significant political and economic reforms, while maintaining a unique blend of a market-driven economy under a socialist regime State-owned enterprises, especially in banking and finance, play a pivotal role in Vietnam’s economy, with the banking sector serving as the backbone, often described as the ‘bloodstream’ of the economy Banks in Vietnam are the primary sources of both short-term and long-term funding for most firms, particularly private enterprises The banking industry is predominantly dominated by State-owned commercial banks, with the State Bank of Vietnam owning over 70% of the equity, and these banks hold about 50% of the market share, resulting in large customer bases that reduce their motivation to enhance profitability or efficiency.
1 There are four biggest State-owned commercial banks, including Vietnam Bank for Agriculture and Rural
Development of Vietnam's banking sector includes major institutions such as the Joint Stock Commercial Bank for Investment and Development of Vietnam (BIDV), the Vietnam Joint Stock Commercial Bank for Industry and Trade (VietinBank), and the Joint Stock Commercial Bank for Foreign Trade of Vietnam (Vietcombank) These leading banks play a vital role in supporting Vietnam's economic growth by providing comprehensive financial services, fostering investment, and facilitating international trade Their strong presence and extensive networks contribute significantly to the development of Vietnam's banking industry and its integration into the global economy.
Vietnamese banks traditionally relied on interest-bearing activities and interbank lending, but the country's integration into the global economy prompted significant changes In 2007, Vietnam's accession to the World Trade Organization (WTO) and the entry of five foreign banks' wholly-owned subsidiaries intensified competition in lending and deposit markets As a result, Vietnamese banks were compelled to shift away from their conventional business models and diversify into non-traditional financial activities to remain competitive and sustainable (Le, 2015; P A Nguyen & Simioni, 2015).
The 2008 US housing market collapse triggered a global subprime mortgage crisis and subsequent financial meltdown, severely impacting the worldwide economy (Y Chen, Wei, Zhang, & Shi, 2013; Demyanyk & Van Hemert, 2009) This crisis led to a slowdown in global economic growth amid rising inflationary pressures, complicating the efforts of central banks' monetary policies Economies highly integrated into global markets, including the US, Europe, and Japan, experienced significant downturns such as negative growth, business closures, bankruptcies, and rising unemployment Financial markets reflected persistent negative signals, fostering widespread pessimism about the economic outlook The root cause of this economic catastrophe was primarily linked to credit crunches and concentration risks within banks’ credit portfolios.
Vietnam’s economy was significantly impacted by the global financial crisis, experiencing reduced industrial production, increased unemployment, and strained bank-customer credit relationships due to declining business activities Since 2009, key economic indicators showed a sharp downturn, worsening from 2011 to 2014, with GDP growth falling to 4.8% in 2011—the lowest since 1999—and double-digit inflation emerging since late 2010 Additionally, total investment, primarily from the state sector, declined from approximately 40% of GDP to about 30%, highlighting the severity of the economic slowdown.
Between 2011 and 2014, Vietnam's real estate market experienced a significant decline due to rising real interest rates and a slowdown in capital inflows, negatively impacting property prices During this period, the country faced a high trade deficit and a near-threshold budget deficit, coupled with increased public debt, which collectively strained economic stability These economic challenges underscored the need for strategic policy measures to stimulate growth and stabilize financial markets in Vietnam.
The Vietnamese financial market and banking industry faced severe challenges due to a slowdown in credit growth, rising non-performing loans, and increasing bad debts, which significantly impacted the operations of commercial banks Weaknesses among bank managers—including insufficient capital buffers, poor management skills, and ineffective risk management strategies—exacerbated the crisis Rapid credit expansion following the 2008–2009 Global Financial Crisis, driven by economic stimulus measures, led to asset quality issues and heightened credit risks for Vietnamese banks This period experienced a surge in non-performing loans, with the ratio rising from under 5% in 2011 to nearly 12% in 2012 and about 15% in 2014, reflecting widespread financial distress Additionally, concentrated credit portfolios increased contagion risks within the banking system, underscoring systemic vulnerabilities during this period.
2015) The number of banks reduced from 52 in 2011 to 43 in 2015 (see Table1.1) because of many insolvency cases and mergers & acquisitions A dozen of weak banks were eliminated.
To address the financial system's challenges, the Vietnamese government launched a comprehensive banking industry restructuring program from 2011 to 2015, emphasizing improved asset quality and diversification into non-credit services, as outlined in Prime Minister Decision No 254/QD-TTg Since 2016, the State Bank of Vietnam has mandated the adoption of Basel II standards, which categorize assets into five classes—corporate, sovereign, bank, retail, and equity—to strengthen banking stability In line with government directives, Vietnamese banks are increasingly adopting diversification strategies to rebuild their assets, liabilities, and income quality, ensuring a more resilient financial sector.
Table 1.1: Descriptive number of banks in Vietnam, 2005-2019
Source: State Bank of Vietnam, System of Credit Institutions, 2020
Banks can adopt various diversification strategies for assets, funding, and income based on their current strength and resources By leveraging available resources, banks aim to expand and diversify their business activities across multiple sectors, reducing risk and enhancing growth potential Effective diversification enables banks to optimize their portfolio performance while maintaining financial stability in dynamic market conditions.
State-owned commercial banks are owned by the State Bank of Vietnam, as outlined in the 2015 Corporate Law To effectively manage risks and boost revenue, these banks implement strategies to limit and disperse risks, aiming to enhance profitability through a balanced approach between risk control and financial performance Sometimes, conflicting regulations and supervisory requirements lead banks to adopt either diversification or concentration strategies; for instance, restrictions on branch expansion, entry, and investments often keep banks focused, while some management boards prioritize risk reduction and opt for diversification to optimize their risk-return profile.
Recent trends show a shift from interbank lending prior to financial turmoil and sovereign debt issues during the 2012 recession, toward a growing focus on consumer loans in recent years (Bezemer & Schuster, 2014) Additionally, Vietnamese commercial banks have begun divesting from non-core business activities, reflected in the decreasing asset diversification index observed from 2011 onwards.
Research background
Modern portfolio theory emphasizes that diversification helps reduce specific risks by investing in a variety of non-correlated assets, aligning with the adage "don't put all eggs in one basket." Banks that incorporate a mix of interest and non-interest income activities can experience more stable revenue streams and fewer fluctuations By diversifying across multiple sectors, banks can mitigate potential failures and optimize resource sharing, supporting the concept that effective diversification enhances financial stability.
Diversification in banks can increase agency problems and elevate agency and opportunity costs, especially when managers exhibit overconfidence leading to poor diversification choices Such decisions may result in financial instability within the banking sector Additionally, due to the unique nature of banks, findings from general corporate finance research may not be directly applicable to the banking industry, highlighting the need for industry-specific analysis.
Although numerous studies have examined the impact of banking diversification on performance, there is no consensus among scholars due to conflicting empirical results Proponents of diversification argue that it offers advantages such as leveraging managerial skills across different products and regions, achieving economies of scale by sharing fixed costs, and providing a comprehensive range of financial services to clients with multiple needs Conversely, advocates of concentration strategies contend that diversification may diminish a bank’s managerial efficiency, especially when investing in areas outside of their core expertise.
1998) Furthermore, diversification increases competition (Winton, 1999) and creates higher agency costs resulting from activities of diminishing value when managers want to reduce their risk (Amihud & Lev, 1981; L Laeven & Levine, 2007).
Before 2010, research on banking diversification primarily focused on developed markets like the US and Europe, where banks were fully mature (V V Acharya, Hasan, & Saunders, 2006; Curi et al., 2015; Elsas et al., 2010; Mercieca et al., 2007; Rossi, Schwaiger, & Winkler, 2009; Stiroh & Rumble, 2006; Yang, Liu, & Chou, 2020) In contrast, there has been relatively limited scholarly attention to this topic in emerging and transition economies, with only a few significant studies such as Odesanmi and Wolfe (2007) and A N Berger, Hasan, and Zhou (2010).
Over the past decade, researchers have increasingly focused on exploring the relationship between diversification, bank risk, and performance in developing and emerging markets In Asia, a region with numerous developing countries, studies have examined groups of countries such as those by N Chen et al (2018) and Moudud-Ul-Huq et al (2018), highlighting regional trends Other research has concentrated on individual countries to understand specific dynamics, including studies on Brazil (Tabak et al., 2011), China (A N Berger, Hasan, & Zhou, 2010), and the Philippines (Meslier, Tacneng), emphasizing the importance of country-specific insights in banking sector analysis.
& Tarazi, 2014), Ghana (Duho, Onumah, & Owodo, 2019), or Vietnam (Batten
The topic of diversification strategy remains a highly relevant area of research for scientists and managers worldwide (Vo, 2016; Y Chen et al., 2013; Luu et al., 2019; Vo, 2017) Empirical studies indicate that the effectiveness of diversification varies across countries, with diversified structures offering more advantages to banks in less developed areas, whereas in developed countries, the benefits are less significant (Doumpos et al., 2016) Additionally, the impact of diversification may differ significantly between bank-based economies like Vietnam and market-based economies, highlighting the importance of contextual factors in strategic outcomes (Mirzaei & Kutan, 2016).
The impact of diversification on risk and performance in Vietnam's banking sector remains debated, raising questions about its long-term benefits Researchers and policymakers have shown keen interest in understanding how asset, income, and funding diversifications influence bank stability and profitability Studies focusing on Vietnam and other Asian countries (Moudud-Ul-Huq et al., 2018; T L A Nguyen, 2018) indicate that foreign-owned asset diversification enhances profit efficiency, though its benefits are primarily short-term While some scholars view diversification as a key strategy to mitigate risks for Vietnamese banks, increased funding diversification has been linked to significant improvements in profitability.
Research indicates that banks can enhance profitability through diversification strategies, with funding diversification playing a significant role in influencing bank risk and performance (Vo, 2017; Vo, 2020) While increased diversification may lead to riskier decision-making, most studies focus separately on revenue or funding diversification, leaving asset diversification underexplored Additionally, there is a notable gap in research regarding the systematic impact of diversification strategies on bank risk and returns during financial distress and the combined effects of multiple diversification approaches, which are crucial for developing optimal portfolio models tailored to specific periods.
Research gap identification
This research addresses existing gaps in the literature on bank diversification, risk, and performance in Vietnam, exploring how diversification strategies impact bank performance and risk, especially during banking crises Key questions include whether diversification strategies effectively influence Vietnamese banks’ risk and performance and how banks can manage these strategies simultaneously The study emphasizes the importance of understanding how banks can effectively combine multiple diversification strategies to achieve optimal risk-return outcomes in the Vietnamese banking sector.
This dissertation analyzes the differences between Vietnamese diversified and concentrated banks regarding risk and return from 2005 to 2019 Focusing on Vietnam individually is essential due to the country's unique economic and political characteristics The fifteen-year timeframe provides a robust data set suitable for econometric analysis, enabling comprehensive insights into the banking sector's performance during this period.
2019 Moreover, banking data are not adequate before 2005, with many missing figures.
This study focuses on the Vietnamese banking crisis from 2011 to 2014, analyzing how diversification influences risk and performance during periods of financial distress According to Dziobek and Pazarbasioglu (1998), government response policies during the 1998 crisis across 24 countries included liquidity interventions, nonperforming-loan management units, bank takeovers, and bank consolidations These policies are relevant in understanding the Vietnamese banking sector’s recovery efforts from 2005 to 2019 Understanding these interventions offers insights into effective strategies for managing banking crises and improving financial stability in emerging markets.
This dissertation explores how the relationship between diversification, bank performance, and risk is influenced by different bank ownership types While existing literature reviews reveal a gap regarding the effects of multiple diversity strategies on Vietnamese banking risk and performance, no studies have examined whether this relationship varies across banks with different ownership structures Therefore, Vietnam presents a unique case to investigate the linkage between banking diversification, risk, and performance within various ownership frameworks.
The following subsections present the objectives and questions of this dissertation.
Research objectives
Diversification has traditionally been viewed as a strategy to enhance bank risk management and performance; however, recent financial turmoil has raised doubts about its effectiveness Despite numerous empirical studies exploring the relationship between diversification strategies and bank profitability, there remains no consensus, largely due to significant variations across different countries and regions Evidence on how asset, income, and funding diversification measures influence bank performance and risk is mixed, highlighting the complexity and geopolitical differences in the outcomes of diversification strategies.
This dissertation investigates the level of diversification among Vietnamese commercial banks and examines how such diversification influences their risk profiles and overall performance, building on prior research in the diversification literature.
From 2005 to 2019, diversification strategies in banking have been comprehensively characterized across three key dimensions: assets, funding, and income These dimensions encompass both the asset-liability structure on the balance sheet and the revenue streams in the income statement, providing a holistic view of bank diversification Additionally, analyzing the combined effects of these strategies enables the identification of optimal diversification models, enhancing banks' overall risk management and financial performance.
This dissertation examines the impact of diversification on banking risk and performance in Vietnam during the banking distress period (2011-2014) It provides practical recommendations for bank managers and prudential authorities in emerging markets to optimize diversification strategies and monetary policies The study aims to enhance the risk management and financial performance of the banking system amid economic turmoil These insights can help banks better navigate financial instability and strengthen overall resilience in challenging economic times.
This dissertation aims to systematically examine how ownership strategies—specifically, state-owned banks and foreign bank subsidiaries—impact the relationship between diversification, risk, and performance Understanding the influence of ownership type provides valuable insights into how different banking structures affect financial stability and profitability By analyzing the role of both domestic and international ownership, the study sheds light on their contribution to risk management and overall performance This research enhances our comprehension of how ownership strategies shape the nexus between diversification tactics and bank performance outcomes.
This study analyzes the Vietnamese banking system, a frontier economy, using secondary data, quantitative methods, and econometric models to provide valuable insights The research offers a comprehensive understanding of financial dynamics within Vietnam's banking sector, making it a valuable reference for future studies Moreover, the methodology and findings can be extended to explore similar financial systems in emerging economies, contributing to ongoing academic and practical research in this field.
Research questions
This study analyzes panel data from 34 Vietnamese banks between 2005 and 2019 using advanced econometric methods to assess the banks' diversification levels The research investigates how diversification influences bank performance and risk, with a particular focus on the banking distress period from 2011 to 2014 The findings offer valuable insights into the relationship between diversification strategies and financial stability in Vietnam's banking sector This dissertation aims to answer key research questions to deepen understanding of how diversification impacts bank resilience and performance amid economic fluctuations.
Research question 1: Do diversification strategies (asset, income, funding) and their combinations impact bank risk and performance?
RQ1.1: Does asset diversification impact bank risk and performance?
RQ1.2: Does income diversification impact bank risk and performance?
RQ1.3: Does funding diversification impact bank risk and performance?
RQ1.4: Can banks combine these three diversification strategies to achieve their expected risk-performance objectives?
Research question 2: Do diversification strategies (asset, income, funding) impact bank risk and performance in the banking distress period?
RQ2.1: Do diversification strategies impact bank risk during banking distress?
RQ2.2: Do diversification strategies impact bank performance during banking distress?
Research question 3: Do bank ownership structures impact the diversification- risk-performance nexus?
RQ3.1: Do ownership structures impact the diversification-risk nexus?
RQ3.2: Do ownership structures impact diversification-performance nexus?
The scope of research
This study analyzes the impact of diversification strategies—asset, income, and funding—on the financial risk and performance of Vietnamese commercial banks, with a focus on banking distress periods It also considers how ownership structures, including state-owned, foreign-owned, and private banks, influence these effects The research is based on a comprehensive sample of 34 Vietnamese commercial banks, representing over 90% of the country's banking sector, including four state-owned banks (three listed), five foreign-owned banks, and twenty-five domestic private banks.
This study analyzes financial data from 2005 to 2019, utilizing secondary sources such as Bankscope, OrbisBankFocus, and Vietstock to ensure data accuracy and credibility The selected timeframe encompasses critical years of Vietnamese banking-system distress, particularly from 2011 to 2014, providing valuable insights into the banking sector’s resilience and challenges during periods of financial instability.
Research procedure and methodology
This study analyzes the impact of diversification strategies on bank performance and risk by examining data from the annual financial statements of 34 Vietnamese commercial banks between 2005 and 2019 Data were sourced from the Bankscope and Orbis Bank Focus databases, providing comprehensive insights into the transmission mechanisms through which diversification influences key financial indicators The research offers valuable understanding of how diversification affects bank stability and profitability within the Vietnamese banking sector over a fifteen-year period.
This study employs three estimation techniques: Pool OLS for panel data, Fixed Effects Model (FEM), and Random Effects Model (REM), complemented by the System Generalized Method of Moments (SGMM) While the Pool OLS model has limitations in capturing individual effects (Kiviet, 1995), FEM and REM are used as alternatives, though they do not address endogeneity issues (Ahn & Schmidt, 1995) To overcome this, the System GMM approach is applied, offering a stable, efficient, and normally distributed estimation of coefficients, effectively handling endogenous phenomena (Hansen, 1982).
We utilize the two-step system GMM (SGMM) estimation method, as recommended by Arellano and Bover (1995) and Blundell and Bond (1998), to effectively analyze panel data with numerous cross-sectional units and relatively few time periods This advanced methodology is employed to accurately estimate our empirical models while addressing potential endogeneity issues The two-step SGMM approach helps prevent bias in results, particularly in exploring the relationship between diversification, bank risk, and performance.
The methodology involves developing research hypotheses aligned with specific research questions and testing these through various experimental models For RQ1, the author estimated the hypotheses using POLS, FEM, REM, and two-step SGMM, establishing a robust baseline analysis Additionally, Quantile regression estimation, detailed in section 3.3 of chapter 3, provides a comprehensive approach to understanding the data This structured methodology ensures rigorous testing of hypotheses to address the research questions effectively.
To address the second research question (RQ2), the author employed the two-step SGMM method to estimate the experimental model and test the hypotheses The estimation covered the entire period from 2005 to 2019, incorporating a dummy variable for the financial distress period (2011-2014) Details about the specific model and estimation process are provided in section 3.3 of chapter 3, ensuring transparency and methodological rigor.
To address the third research question (RQ3), the study employs a two-step SGMM estimation method incorporating interaction variables to analyze how ownership structure influences the relationship between diversification strategies and banking risk and performance This approach allows for a nuanced understanding of the impact of ownership on the effectiveness of diversification in banking sectors.
The research steps are expressed in figure 1.2 below.
Research data collection and processing
Variables descriptive statistics Analysis on cross-correlation matrix of variables
Multivariate regression with POLS, FEM, REM and two-step SGMM
Research contributions
This dissertation offers valuable insights for bankers and regulators by highlighting the empirical relationship between diversification strategies, bank risk, and performance, particularly during challenging periods These findings assist bank executives in making informed strategic decisions related to operations, investments, and financing, ultimately guiding effective management and risk mitigation.
This dissertation offers valuable insights for policymakers in the banking sector by enhancing their understanding of the relationship between bank diversification and risk-performance The empirical findings equip government agencies with comprehensive information to inform more effective regulation and decision-making Ultimately, these insights aim to support the development of strategic policies that promote financial stability and optimized bank performance.
This study examines how ownership structure influences the impact of diversification on bank risk and performance across different types of banks, including state-owned banks, domestic private banks, and foreign banks The research methodology involves analyzing key variables that measure diversification, risk, and performance to determine whether ownership structure moderates these relationships Findings suggest that the effect of diversification varies depending on ownership type, with state-owned banks potentially experiencing different risk and performance outcomes compared to private and foreign banks The results provide valuable insights into how ownership structure shapes the effectiveness of diversification strategies in banking institutions.
In the literature, this dissertation fills up the following gaps:
Vietnam is a young and emerging market with limited research on the relationship between diversification, risk, and performance in its banking sector This study aims to fill this gap by examining how diversification strategies—specifically asset, income, and funding diversification—affect bank risk and performance The primary contribution is to enhance academic understanding of these dynamics and identify the optimal combination of diversification strategies for improved banking outcomes Ultimately, the research seeks to determine the most effective model of diversification to maximize bank performance while managing risk.
Despite existing research, significant gaps remain regarding how financial distress influences the relationship between diversification and bank risk and performance This study aims to fill these gaps by providing empirical evidence on how diversification impacts banks' risk profiles and performance differently during periods of financial turmoil.
The ownership structure of banks significantly influences their risk and performance by affecting customer service quality, information asymmetry, and the range of products offered This study investigates how different ownership types—state-owned and foreign-owned—impact the relationship between bank diversification, risk, and performance, addressing a gap identified in existing literature By incorporating dummy variables for ownership structures alongside macroeconomic, industry-specific, and bank-specific factors, the research aims to provide a comprehensive analysis of how ownership influences banking risk and financial performance.
Structure of the dissertation
This dissertation is organized into five chapters, each exploring the relationship between bank diversification, risk, and performance in Vietnam It examines how ownership strategies influence these dynamics and considers the impact of financial turmoil on bank operations Each chapter provides a detailed analysis of these factors, offering valuable insights into how diversification affects bank stability and performance in the Vietnamese banking sector This comprehensive study enhances understanding of risk management and performance optimization within the context of evolving financial environments.
This chapter provides an overview of the dissertation, focusing on empirical research exploring the relationship between bank diversification strategies, risk, and performance It examines how banking crises and ownership structures influence these dynamics The section outlines the research motivation and background, defines key objectives and questions, describes the scope and methodology, and summarizes the main findings and contributions, offering a comprehensive introduction to the study's framework and significance.
Our empirical analysis reveals significant insights into the impact of diversification strategies on bank risk and return, highlighting that these effects vary across different bank types, including state-owned banks, domestic private banks, and foreign banks The study demonstrates that diversification approaches influence bank performance differently depending on the ownership structure, with notable variations observed during Vietnam’s financial distress period in 2011 These findings underscore the importance of tailored diversification strategies to optimize risk management and profitability in the Vietnamese banking sector.
Based on the 2014 research findings, the author offers valuable recommendations and policy implications for bankers and regulators to enhance banking practices and regulatory frameworks These insights serve as a foundation for future studies, encouraging further exploration of the topic to drive ongoing improvements in the financial sector.
Chapter 2: Literature review and hypotheses development
Chapter 2 offers an extensive review of the literature on bank diversification, including key definitions, foundational theories, and various diversification types, providing a comprehensive theoretical background It also examines empirical studies on bank performance and risk, clarifying the roles of dependent, explanatory, control, and dummy variables in banking research Additionally, the chapter explores the relationship between bank diversification, ownership structure, risk, and returns during economic downturns, identifying research gaps and informing the development of hypotheses This comprehensive literature review sets the stage for Chapter 3, which employs various research methods to test these hypotheses.
This chapter details the empirical research design used to test the hypotheses outlined in Chapter 2, comprising four key sections First, it describes the data and sample selection, including the study period and data-processing techniques to ensure data accuracy Second, it covers the preliminary development and construction of variables essential for the analysis Third, the chapter explains the methodology employed to measure diversification, bank risk, and performance, ensuring robust and reliable results Finally, it presents additional analyses and robustness checks to validate the findings and strengthen the overall credibility of the research.
Chapter 4 Empirical results and discussion
This chapter presents regression results from empirical econometric models detailed in Chapter 3, analyzing the impact of various diversification strategies and their interactions on bank performance and risk during periods of banking distress and restructuring An additional comparison examines how these effects differ across various ownership types The findings are interpreted in relation to initial hypotheses, providing insights that address the key research questions regarding the effectiveness of diversification strategies in enhancing performance and managing risk.
Based on the solid empirical findings from Chapters 3 and 4, Chapter 5 offers a comprehensive summary of the dissertation It revisits the core research questions, briefly reviews the methodology and hypotheses, and highlights key results, providing a clear overview of the study's contributions.
This article highlights the key findings from various models, emphasizing their combined significance for the banking and financial system in Vietnam It underscores the academic contributions and policy implications, offering valuable insights for stakeholders such as the State Bank of Vietnam and bank managers to support strategic decision-making aimed at ensuring stable and sustainable growth The chapter concludes by acknowledging the study’s limitations and proposing directions for future research to further enhance understanding in this area.
LITERATURE REVIEW AND HYPOTHESES
Bank diversification definition
Diversification is a widely studied concept across multiple fields, including corporate management, banking, finance, engineering science, and biology Its meaning varies depending on the research context, necessitating a clear and comprehensive definition that is both theoretically sound and practically applicable (Boone, Colombage, & Gunasekarage, 2011; Olo, 2009) Generally, diversification refers to the act of making things dissimilar or different, with each industry tailoring the concept to suit its specific characteristics and requirements.
The term “diversification” can be approached in 2 directions: (1) diversification in investment; and (2) diversification in operative activities.
Diversification, as defined by A N Berger (1995), is a strategy that involves allocating investments across various financial instruments to maximize performance and minimize risk In the finance sector, this approach helps investors spread their investments to reduce volatility and enhance potential returns Additionally, Booz, Allen, and Hamilton (1985) emphasize that a company's diversification strategies are driven by core business objectives such as growth, risk mitigation, and establishing a solid business platform Implementing effective diversification techniques is essential for financial success and long-term stability.
Diversification allows organizations to expand their product lines and enter new markets, which can enhance performance and reduce risk (Ansoff, 1957) Companies often introduce new products for new markets to boost profits and foster growth, leading to changes in the product-market structure They can also diversify by venturing into new fields beyond their core business through strategies like self-development or mergers and acquisitions (Berry, 1971; Ramanujam & Varadarajan, 1989) The level of diversification is determined by the revenue contribution of different product types—core, related, and unrelated to the core business—and each category involves distinct suppliers and logistics channels (Rumelt, 1974; Pitts, 1977; Pitts & Hopkins, 1982) Implementing a diversification strategy often involves modifying business plans, customer models, or technology applications to develop new products or markets (Kenny, 2009).
In both approaches, diversification seems to be considered a means and method to improve a firm’s performance and eliminate risks (Hoskisson & Hitt, 1990; H.Markowitz, 1952).
Banking sector diversification strategies focus on creating differentiated products and services, expanding into new operational areas, and broadening geographical reach to gain a competitive advantage and boost revenues (A N Berger, Hasan, & Zhou, 2010; Elsas et al., 2010) Besides product diversification, geographical expansion is a key approach, allowing banks to enhance their market presence and profitability (Mercieca et al., 2007) Many banks combine both types of diversification by offering a wider range of services such as securities trading, insurance, and other non-traditional activities (Baele et al., 2007; Christiansen & Pace, 1994; Ebrahim & Hasan, 2008; Kahloul & Hallara, 2010; Tabarrok, 1998) Ultimately, banking managers can implement diversification strategies through expanding their activities, assets, and liabilities to achieve growth and stability.
In this dissertation, banking diversification is defined as the strategic combination of various activities aimed at diversifying income, assets, and liabilities This approach helps banks effectively manage risk and enhance overall operational performance Emphasizing the importance of diversification, the study highlights its role in strengthening financial stability and promoting sustainable growth in the banking sector.
Classification of bank diversification strategies
Previous research on diversification highlights multiple dimensions, including deposit and non-deposit activities, assets, multi-industry operations, revenue streams, products, services, activities, and geographic expansion (A N Berger, Hasan, & Zhou, 2010; Lin, 2010; Mercieca et al., 2007; Gambacorta, Scatigna, & Yang, 2014; Kiweu, 2012) For instance, Liang and Rhoades (1991) identify three methods of bank diversification: credit activities, stock investments, and holding central bank funds, which are classified as product or income diversification depending on the context Ebrahim and Hasan (2008) categorize these strategies under product diversification, emphasizing the multifaceted nature of bank diversification approaches.
Banks can enhance their risk management strategies by diversifying their credit portfolios and geographic locations, as highlighted in the 1991 study Additionally, Saksonova and Solovjova (2011) identify two primary methods of bank diversification: expanding loan portfolios and broadening investment activities, which contribute to increased financial stability.
The classification of business diversification has evolved significantly since Rumelt (1974), who identified four main categories: single business enterprises focusing on one core area, dominant business firms expanding within their primary focus, related diversification involving expansion into closely related areas, and unrelated diversification across different sectors Many scholars adopt this framework, while Knecht (2009) offers a more generalized approach, classifying diversification into related and unrelated types, as well as horizontal, vertical, and conglomerate forms Additionally, diversification can be categorized geographically, distinguishing domestic from international expansion, with international diversification often grouped with horizontal and vertical strategies based on value chain contributions These classifications help businesses understand diversification strategies and their implications for growth and competitiveness.
Diversification in the banking sector is a widely debated topic, with various perspectives on its significance Among these, the classification by Mercieca et al (2007) is particularly well-known, identifying three key dimensions of banking diversification The first dimension is financial products and services diversification, which emphasizes expanding and broadening the range of offerings to meet diverse customer needs and enhance competitive advantage.
(2) geographic diversification, and (3) a combination of geographic and business line diversification
Financial products and services diversification is a strategic approach that banks use to develop new offerings and optimize existing ones to meet customer demands According to Galbraith (2008), there are three main types of product diversification: related, linked, and unrelated Related diversification involves expanding into areas closely connected to existing business activities, such as manufacturing, marketing, or technology, creating a strong link among production processes Linked diversification transfers shared resources and core capabilities into new industries, aiming to establish sustainable competitive advantages and create more effective combined operations, though it does not guarantee achievement of strategic goals Unrelated diversification entails making investments in industries unrelated to the company's current value chain, helping firms survive recessions, boost competitiveness, and balance seasonal sales This strategy also allows for the introduction of new products that can enhance consumption and market presence.
Diversification techniques offer banks significant advantages by helping to disperse and minimize risks, increase income, and reduce operating costs Given that many banks have faced bankruptcy issues due to debt recovery problems, it is essential for banks to develop non-credit services and innovative customer offerings Strengthening these diversification strategies enhances competitive advantages and ensures the sustainable stability of a bank's core activities, making the selection of effective diversification methods crucial for long-term success.
Geographical diversification, also known as international diversification, involves spreading investments across different countries to reduce risk The primary research focus in this area is understanding country diversification, which examines how investing in various nations can improve portfolio stability and returns By diversifying across borders, investors can mitigate country-specific risks and tap into emerging markets, enhancing overall investment performance This approach is essential for building resilient portfolios in a globalized financial landscape.
Bracker, 1989; Lu & Beamish, 2004), which means that businesses will consider each country's corresponding to each different market The second direction is regional diversification.
In the era of globalization, international diversification has become essential for commercial banks seeking growth and risk management Banks can achieve this by expanding their presence in new regions through opening branches, subsidiaries, or mergers across borders, often in foreign countries However, implementing international diversification requires careful feasibility assessments, including strategic realignment, facility upgrades, and increased financial investment (Goetz, Laeven, & Levine, 2013; Liang & Rhoades, 1991) Geographic diversification involves expanding assets across various locations, with international diversification specifically referring to spreading banking activities into foreign markets via branches or subsidiaries (Berger et al., 2010) The main objectives for adopting international strategies are to increase market share, attract more customers, and mitigate country-specific risks (Lin, 2010) Studies typically measure this type of diversification using dummy variables or ratios of foreign assets to total bank assets, highlighting its significance in global banking strategies (Ugwuanyi, Ani, Ugwu, & Ugwunta, 2012; Lin, 2010).
A combination of geographic and product diversification is the most effective strategy for enhancing bank efficiency By expanding their international presence and introducing new products and services in each market, banks can better meet diverse customer needs such as money transfer, loans, and other financial solutions This strategic approach enables banks to achieve higher operational effectiveness and greater market reach (Brighi & Venturelli, 2016).
Geographical and product diversification analysis typically requires primary data or specialized information not available in standard financial reports As such, this data is limited in accessibility and may lack consistency with the secondary data used in this research Therefore, the study relies solely on secondary data, specifically audited financial reports of the sample banks, to ensure data reliability and comparability.
Banking product and sectoral diversification, also known as industrial or business-line diversification, involves expanding loan portfolios, including net impairments on mortgages and non-mortgage lending (D’Souza & Lai, 2003) In Vietnam, most banks offer similar financial products, primarily expanding their branch networks domestically, while only a few venture overseas due to capital constraints Over time, both product and geographic diversification in Vietnamese banks remain relatively stable and have limited impact on overall bank performance.
This dissertation explores the components of bank diversification by integrating Knecht (2013) classification, with a focus on narrowing down to content-based business diversification The study examines three key types of bank diversification: asset diversification, income diversification, and funding diversification Notable fluctuations in these diversification indexes are highlighted in Figure 1.1, illustrating significant movements across all three areas.
2.2.1 Asset diversification in the banking sector
The 2008 financial crisis exposed significant weaknesses in traditional banking business models, particularly reflected in bank assets Large US investment banks faced severe challenges, with Lehman Brothers declaring bankruptcy, Bear Stearns merging with JP Morgan Chase, and Bank of America acquiring Merrill Lynch Additionally, JP Morgan and Goldman Sachs transitioned into commercial banks, illustrating the dismantling of the traditional separation between commercial and investment banking This shift marked the end of the Glass-Steagall Act's separation of banking sectors and the rise of the universal banking system introduced by the Gramm-Leach-Bliley Act of 1999, ultimately leading to the decline of large, independent investment banks during the crisis.
Global banking practices highlight the ongoing debate over diversifying bank assets, which influences permitted banking activities worldwide The swift resurgence of the universal banking model amid economic crises suggests that integrating multiple banking services—such as universal banking and banc-assurance—offers a highly efficient structure Policymakers increasingly view this combined approach as optimal for enhancing bank stability and operational efficiency in the current financial landscape.
Measurement of asset diversification levels in the banking sector
According to L Laeven and Levine (2007), asset diversification (AD) is measured by the ratio of non-loan assets to total earning assets, encompassing underwritten securities and investments This metric helps assess the level of diversification in an institution's asset portfolio, indicating its exposure to different asset types Implementing asset diversification strategies can enhance a financial institution's risk management and overall financial stability.
In recent researches, Curi et al (2015); Elsas et al (2010); T L A Nguyen
Theories of bank diversification
The theory of financial diversification is a fundamental topic in many economic studies, primarily focusing on whether diversification enhances firm value Empirical research approaches to diversification mainly stem from finance and strategy perspectives Financially, diversification reduces specific types of risk for companies and individual investors, but higher management costs associated with diversification can make it a less attractive investment option (Amihud & Mendelson, 1986; P G Berger & Ofek, 1995; Hughes, Lang, Mester, & Moon, 1999; McConnell & Servaes, 1990) Strategically, business diversification is crucial for entering new markets and launching innovative products, thereby strengthening market power and competitive advantage, which ultimately increases enterprise value (Ansoff, 1957).
Diversification strategies help firms mitigate unsystematic risks by spreading investments and leveraging client information, making them advantageous for risk avoidance (Fama, 1985) Conversely, concentration strategies can enhance efficiency by reducing agency problems, utilizing core expertise, and focusing on competitive strengths—embodying the principle of "putting all your eggs in one basket" to maximize potential (P G Berger & Ofek, 1995; Jensen, 1986; Winton, 1999).
Firms pursue diversification strategies to gain market power, address agency problems, or leverage their resource bundles for competitive advantages, as highlighted by Montgomery (1994) These strategies are rooted in key theories, including market power theory, agency theory, and the resource-based view, which collectively explain diversification’s role in maximizing profits Additionally, the market-based view and resource-based view analyze the normative aspects and drivers of diversification focused on profit maximization Similar to these theories, Modern Portfolio Theory also supports diversification as an effective approach to risk management in portfolio optimization.
According to Porter (1980), companies can position themselves effectively in the market by adopting strategies that differentiate them from competitors Diversification is a key strategic approach to tackling competition, enabling firms to expand their offerings and reduce market risks (Barney) Implementing differentiation and diversification strategies can enhance a company's competitive advantage and market presence.
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(1994) The same conclusions were confirmed by Palich, Cardinal, and Miller
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According to agency theory, conflicts of interest between owners and managers create implicit costs, known as agency costs, which include expenses to monitor and incentivize managers to align their actions with the company's goals These costs may also restrict owners from making decisions solely for profits and can lead to residual losses when managers' actions deviate from owners' expectations (Jensen & Meckling, 1976) Managers sometimes prioritize their own benefits over the company's profitability, especially when owners and managers have differing risk tolerances, with owners typically concerned with systemic risk and managers with unsystematic risk (Jensen, 1986) This issue is more pronounced in companies with large free cash flows, as managers may prefer to reinvest retained earnings for higher returns rather than pay dividends.
Diversification is usually seen as a solution for managers (Jensen & Meckling,
Managers with free cash flow often expand into low-profit areas to strengthen their management capabilities and reduce overall business risk, as noted by Jensen (1986) and Montgomery (1994) However, these expansion decisions can lead to increased agency costs, since agency theory suggests that benefits to managers may come at the expense of shareholders Consequently, diversification driven by managerial incentives can adversely affect the company's profitability.
Resources Based View (RBV) Theory
The Resources Based View (RBV) theory has been developed in many previous studies, such as that of (Barney, 1991; Teece, Pisano, & Shuen, 1997; Wernerfelt,
The Resource-Based View (RBV) theory, introduced by Edith Penrose in 1959 and further developed by Rubin in 1973, emphasizes that companies leverage their unique set of resources to achieve and sustain a competitive advantage According to RBV, strategic managerial efforts are intentionally directed toward maximizing these valuable resources, making it a critical framework for analyzing long-term competitive success This approach underscores the importance of internal capabilities and resources in maintaining a company's market position, making it essential for researchers studying sustainable competitive advantages.
Resource-Based View (RBV) highlights how companies utilize their unique resources to gain a sustainable competitive advantage and enhance long-term performance, especially within Porter's five forces framework Key to this is the concept that certain resource positions create barriers—such as first-mover advantages and resource location barriers—that protect firms from competitors and boost performance According to Lieberman and Montgomery (1988), occupying valuable resources can negatively influence competitors’ costs and benefits, providing a strategic shield Montgomery (1994) emphasizes that resource location barriers can lead to higher performance when a firm’s resources afford it a competitive edge Prahalad and Hamel (1996) argue that successful companies sustain competitive advantages through distinctive core competencies Furthermore, RBV advocates for diversification into new markets based on existing resource capacities—a strategy that not only creates entry barriers but also allows firms to share costs across related activities, generating economies of scale Barney (1991) suggests that resource capacity-based diversification enhances firm performance by leveraging shared core competencies and management skills across multiple industries Ultimately, RBV offers strategic guidance for firms to position themselves across industries by optimizing resource allocation, fostering asset synergy, and reducing costs to outperform rivals, aligning with Porter’s strategic principles for competitive advantage.
The sharing of functions, resources, and skills within companies can lead to sustainable competitive advantages and cost reductions, ultimately maximizing profitability According to the Resource-Based View (RBV), there is a positive relationship between diversification and a company's financial performance (Mulwa, Tarus, & Kosgei, 2015).
Diversification is a fundamental concept in modern investment theory, widely recognized by financial investors to manage risk effectively It primarily addresses specific risks by spreading investments across multiple assets, reducing the impact of individual asset fluctuations on the overall portfolio As the adage "do not put all eggs in one basket" suggests, building a diversified portfolio with investments across different firms and markets can significantly lower risk For example, holding shares in various companies and sectors minimizes the adverse effects of a single company's stock decline Additionally, diversification enables firms to share resources across multiple sectors, helping to mitigate potential failures and stabilize returns.
Bank diversification is rooted in financial theory and strategic analysis of costs and benefits, aiming to optimize a bank's performance and risk profile Managers and banks choose diversification strategies for various reasons, including achieving synergy, gaining market power, accessing new resources, and managing agency-related motivations According to Nguyen, Skully, and Perera (2012), key drivers of bank diversification include competitive pressures, interest expenses, advances in banking technology, market share considerations, default risks, and macroeconomic factors, highlighting both managerial decisions and normative benefits of diversification.
Accelerating the launch of new financial services and cross-selling a variety of financial products and traditional lending solutions presents a significant opportunity to boost the bank’s revenue This strategic approach enhances sales channels, diversifies income streams, and improves overall financial performance, aligning with industry insights from Tabak et al (2011) and Winton.
Concept and measurement of bank risk and performance
2.4.1 Concept and measurement of bank risk
Bank risk is a multi-dimensional concept encompassing various approaches, primarily defined as the potential loss of assets or a decline in actual profits compared to expected profits It includes unexpected uncertainties in the business and production processes that can adversely impact an enterprise's survival and growth In the banking industry, risk plays a critical role in assessing the profitability and efficiency of a bank's operations, influencing decisions on profits and costs (Kaplan & Garrick, 1981; Rothschild & Stiglitz, 1970) Attempting to eliminate risk from the estimation models can lead to inaccurate forecasts and hinder effective policy formulation for bank operations and capital management.
This study evaluates the impact of diversification strategies on bank risk using five key risk indicators To maintain accuracy, market risk is excluded due to the inclusion of both listed and unlisted banks in the dataset The dissertation presents a detailed measurement approach for each of the five risk indicators, providing insights into how diversification affects bank risk profiles These findings offer valuable implications for banking risk management and strategic decision-making.
The ZSCORE model is a reliable bankruptcy risk forecasting tool rooted in multidimensional statistical analysis, developed by Altman in 1968 It utilizes a five-factor model and multivariate discriminant analysis to predict a company's likelihood of failure when its score falls within a specific range The ZScore model predicts bankruptcy with approximately 95% accuracy within one year prior to failure, though its predictive accuracy diminishes over time, dropping to 72% two years before failure, 48% three years prior, 29% four years prior, and less than 36% five years before the event.
The term "failure" encompasses not only bankruptcy or insolvency but also includes any financial distress where a company cannot meet its debt obligations Following Altman's research, increasing scholarly interest has emerged in bankruptcy risk analysis, leading to the development of more sophisticated predictive models Many of these models have been tailored to the banking and financial sectors, with a focus on data from the 1970s onward In bank risk literature, the Z-Score is widely recognized as a key indicator for assessing financial health and predicting bankruptcy (Adusei, 2015; Andries).
& Capraru, 2013; Čihák, 2007; Diaconu & Oanea, 2014; Eisenbach, Keister, McAndrews, & Yorulmazer, 2014; Fiordelisi, Marques-Ibanez, & Molyneux, 2011; Groeneveld & de Vries, 2009; Lepetit, Nys, Rous, & Tarazi, 2008; Mercieca et al., 2007; Miklaszewska, Mikolajczyk, & Pawlowska, 2012; Petrovska & Mihajlovska, 2013).
Due to difficulty in the calculation when applying the Z - Score model measuring bank stability, Mercieca et al (2007) proposed the ZSCORE estimation equation with the following estimating factors:
ℴ𝑁𝑁𝑁 Where: ROA is Return on assets, E/TA: Equity / Assets ratio, ℴROA: The standard deviation of ROA.
The ZSCORE effectively links a bank's capitalization with its return on assets (ROA) and risk, measured by return volatility It indicates the number of standard deviations that a bank's asset returns must decline before insolvency occurs Consequently, a higher ZSCORE signifies a safer and more financially stable bank.
Because of the Basel treaty, banks should be more focused on managing their capital to avoid the risk of default A N Berger and Di Patti (2006), developing a
A robust "credit model" emphasizes the importance of equity in banks with competitive credit operations Bank capitalization is often represented by the equity-to-asset ratio, where a higher ratio indicates a stronger financial position Maintaining a high equity-to-asset ratio reduces bankruptcy risk, contributing to the stability and soundness of the banking institution.
In addition to the ZSCORE model widely used in most studies related to bank risk, Segoviano and Goodhart (2009) presented a method to measure banks' risk.
This report introduces methods to assess the risk of both linear and non-linear banks by analyzing changes in the banking system across economic cycles It evaluates each bank's risk in relation to economic impacts, aiming to determine the likelihood of bank distress The assessment relies on two key indicators: Joint Probability of Distress (JPoD), which estimates the chance that all banks in a portfolio will become distressed, and the Banking Risk Index (BSI), reflecting the expected number of distressed banks A higher number of distressed banks indicates increased system-wide risk.
The ZSCORE model developed by Mercieca et al (2007) is a widely used method for measuring bank risk, gaining popularity due to its effectiveness This model is particularly suitable for capturing the unique characteristics of banking systems across different countries Its growing adoption highlights its relevance and reliability in banking risk assessment, as detailed in Appendix 6.
Recent studies on bank risk assessment incorporate various indicators alongside Z-score, such as RAROA (Risk-adjusted returns on assets), RAROE (Risk-adjusted returns on equity), SDROA (Standard deviation of Return on assets), and SDROE (Standard deviation of Return on equity), as evidenced by research from Edirisuriya et al (2015), Lee et al (2014), Meslier et al (2014), and Moudud-Ul-Huq et al (2018) These metrics are straightforward to calculate and provide comprehensive insights into a bank’s risk profile.
2.4.2 Concept and measurement of bank performance
Berger and Mester (1997) emphasize that the performance of commercial banks is determined by their ability to generate maximum output revenue while minimizing input costs They define effective bank performance as the relationship between output revenue and input resource utilization, highlighting that top-performing banks efficiently convert input resources into profitable outputs Ultimately, the most successful commercial banks are those that achieve the highest output revenue with the lowest input resource expenditure.
Operational efficiency in commercial banks can be evaluated through three key approaches: minimizing costs by utilizing the same input factors such as capital, facilities, and labor to generate consistent output; maintaining inputs while increasing output to improve productivity; and employing more inputs with output growth surpassing input expansion In this study, a commercial bank is deemed effective when it achieves the highest possible output revenue with the same input resources as competitors, but at the lowest operational cost.
Up to now, there are two widely used measures of bank performance: structural approaches and non-structural approaches (Hughes & Mester, 2008).
The non-structural approach to measuring banking performance remains the most traditional and widely used method It evaluates bank performance through key financial indicators such as return on equity, return on assets, return on sales, and the costs ratio Additional metrics include Tobin's Q index, which compares the market value of a bank's assets to their book value; the Sharpe index, assessing the return earned per unit of risk; and the capital adequacy ratio, highlighting a bank's financial stability (Hughes & Mester, 2008).
As for the structural approach, researchers will rely on the cost, revenue, and (or) profit functions to analyze banking performance (Hughes & Mester, 2008).
This study evaluates bank performance using a nonstructural approach, focusing on two widely recognized indicators: Return on Assets (ROA) and Return on Equity (ROE) These metrics are extensively used in previous research to assess financial performance (Edirisuriya, Gunasekarage, & Dempsey, 2015; C.-C Lee, Hsieh, & Yang, 2014; Meslier et al., 2014; Moudud-Ul-Huq et al., 2018) The calculations for ROA and ROE are outlined below.
Theoretical overview of banking crisis
A banking crisis occurs when central banks and financial authorities detect a shock with the potential to escalate into a systemic threat to the entire financial system (G Caprio and Klingebiel, 1996; Ergungor and Thomson, 2005) Key policies influencing such crises include bank runs, which can lead to closure, mergers, or government takeovers of financial institutions Additionally, if no runs occur, the failure or government intervention in large financial institutions often signals the onset of broader instability across the banking sector (Kaminsky & Reinhart).
Gonzalez-Hermosillo, Pazarbaşioğlu, and Billings (1997) utilize Central Bank intervention policies as signals to identify banking crises Later, Bagatiuk (2009) characterizes a bank in crisis as one with a revoked license or under special oversight by the Central Bank or debt management agency This definition is widely accepted in academic research and provides a standard understanding of banking crises.
Many researchers have attempted to quantify banking crises using technical indicators, such as the money market pressure index derived from central bank behavior prior to crises (Kibritieweil, 2003; Von Hagen and Ho, 2007) This index highlights that a sharp increase in alarming debt levels or ongoing bank runs significantly reduce commercial banks' liquidity In response, central banks typically raise required reserve ratios to address liquidity shortages and adjust short-term interest rates to stabilize the financial system during these periods.
The banking debt crisis in Vietnam
Dziobek and Pazarbasioglu (1998); Hawkins and Turner (1999) surveyed the crisis response policies in developed and developing markets The survey documented
During the Vietnamese banking crisis from 2011 to 2014, the government employed four key crisis response strategies First, the Vietnamese government and central bank provided liquidity interventions, supporting banks with more than 50% of their capital, identifying them as crisis banks Second, a nonperforming-loan management unit was established to facilitate restructuring, with banks holding over 3% nonperforming loans required to sell such debt to the Vietnam Asset Management Company (VAMC), established in 2013 Third, the State Bank of Vietnam or third parties took over ownership or management of crisis-affected banks to stabilize the banking sector Lastly, systemic consolidation was encouraged, where strong banks merged with weaker ones to enhance management quality, adopt advanced technology, and reduce nonperforming loans, thereby improving overall banking system efficiency.
In 2012, the State Bank of Vietnam implemented a major banking system restructuring to address sub-prime debt issues, resulting in restrictions on nine banks, including Navibank, Trust Bank, Western Bank, GP Bank, Tien Phong Bank, Habubank, Ficombank, Tin Nghia Bank, and Saigon Bank Mergers emerged as the primary solution, with notable consolidations such as Ficombank, Tin Nghia Bank, and Saigon Bank forming Saigon Commercial Bank (SCB) in December 2011, and Habubank merging into Saigon Hanoi Bank (SHB) in August 2012 By the end of 2014, the Vietnamese banking sector had reduced from 42 banks in 2011 to 35 banks still operating nationwide.
Previous studies on banking crises highlight several key determinants, notably bank capital, which significantly influences the stability of the banking system (Demirguc Kunt, Detragiache, & Merrouche, 2013; Morrison & White) Investigating these factors within the context of Vietnam is crucial to understanding and enhancing the resilience of its banking sector.
2005) Second, asset quality refers to a group of determinants that could deteriorate the asset side of the bank balance sheet (M L Laeven, Ratnovski, & Tong,
Non-performing loans (NPLs) serve as a critical indicator of bank asset quality, with higher NPL levels signaling operational inefficiencies and increased risk Maintaining sustainable high income is vital for boosting a bank's capital and ensuring its long-term economic viability, thereby reducing the likelihood of failure Additionally, ownership structure indicators play a significant role in assessing the overall health of the banking system, providing insights into potential stability or vulnerability.
Determining the specific level of non-performing loans (NPLs) that can trigger a financial crisis remains challenging While some studies consider a 10% NPL ratio as an indicator of a looming crisis, this threshold varies and is often subject to context Understanding the critical NPL level is essential for effective risk management and maintaining financial stability within banking sectors.
According to G Caprio and Klingebiel (1996), non-performing loans (NPLs) typically account for 5-10% of total loans, but Moody’s Investors Services reports that in Vietnam between 2011 and 2014, NPLs ranged from 10-15%, more than doubling the central bank’s official figures (Sugiyarto, 2015) Consequently, this period is identified as the Vietnamese bank debt crisis or financial distress phase The Vietnamese banking system is believed to have begun recovering from 2016 onward, following the implementation of Basel II regulations mandated by the State Bank of Vietnam.
The impact of diversification on bank risk and performance
Although the concern on the impact of diversification on banks' risks and performance is discussed in various articles, the conclusion of this topic is still unclear.
Diversity supporters highlight several economic benefits, including economies of scale, tax advantages, market power, capital structure optimization, and the impact of co-insurance Diamond (1984) emphasizes the importance of economies of scale, arguing that banks can leverage their existing infrastructure to offer a broader range of services to customers Additionally, Drucker and Puri (2005) report that diversification leads to a reduction in cost per unit for banks, reinforcing the argument that diversification enhances operational efficiency and profitability.
Numerous authors have documented the tax benefits associated with diversification strategies Specifically, offsetting profits and losses across various banking activities or within intra-firm transactions can provide significant tax advantages (Majd & Myers, 1987; Palich et al., 2000).
Diversification plays a key role in stabilizing the banking capital structure, enabling banks to use profits from various segments to service debts without jeopardizing overall financial health This strategy also provides a competitive advantage, allowing banks to outbid rivals through shallow price strategies Moreover, banks employing diversification tend to enjoy lower funding costs due to more flexible cash flows, as evidenced by research on banking bonds and mergers from 1991 to 1998, which showed a significant reduction in funding costs post-M&A Additionally, engaging in mergers with insurance firms or entering unrelated sectors can help banks mitigate failure risks and enhance financial stability.
D'Souza and Lai (2002) found no significant evidence linking sector diversification or bank size to overall bank profitability, highlighting that diversification of banking portfolios and business lines can be pivotal for long-term success Although their study did not observe significant scale effects in bank mergers, they emphasized the importance of economies of scale in creating more powerful financial institutions Unification between banks and related business lines can lead to a stronger, more competitive entity in the banking sector.
This article examines the impact of mergers and acquisitions between financial institutions on overall performance, focusing on changes in portfolio composition as a key indicator Consistent with D'Souza and Lai (2002), it highlights how merger agreements influence portfolio financing decisions made by the merged bank Their research also explores the broader implications of such mergers for the efficiency of bank-based financial markets.
According to Boyd and Prescott (1986), a diversified structure is optimal under the delegated supervision approach, promoting extensive diversification However, V Acharya, Saunders, and Hasan (2002) caution that diversification can entail drawbacks, such as implicit costs for banks, which may arise from weakened managerial oversight, increased risk in loan portfolios, and limited experience in highly competitive sectors.
Geographical diversification offers banks significant economic advantages, including access to diverse capital markets and the opportunity to strengthen their brand and increase market share Expanding operations can improve scale efficiency and reduce costs, while establishing branches in tax havens like Panama or the British Kingdom can provide tax benefits However, this strategy also entails costs and risks such as investment and training expenses, exchange rate fluctuations, political instability, and legal restrictions Despite these challenges, geographical diversification remains a popular strategy for banks aiming to diversify their business, grow their market share, and enhance their overall value.
2.6.1 Asset diversification, bank risk, and performance
Asset diversification and bank risk
Diversification plays a crucial role in reducing bank risk, as evidenced by previous empirical studies, particularly when income from various activities is not perfectly correlated Researchers highlight how diversification can serve as an effective tool to prevent and address banking problems (Kashyap & Stein, 1995), challenging traditional portfolio theory by encouraging banks to diversify their loan portfolios to mitigate credit risk For example, Tabak et al (2011) found that in Brazilian banks, greater diversification of credit portfolios reduces risk The Basel Committee on Banking Supervision (1991) also reported that many banking crises over the past three decades were linked to concentration, emphasizing the importance of diversification in maintaining financial stability Empirical evidence from Argentina and Austria further supports this view, demonstrating that diversification is vital for risk mitigation in banking sectors across different economies (Bebczuk & Galindo, 2008; Rossi et al., 2009).
Research indicates that banks specializing in a particular sector tend to experience lower credit risk compared to the overall banking system Studies show that concentrated banks often have reduced variability in credit loss, suggesting greater stability Specifically, the standard deviation of credit losses has been found to be lower in most highly concentrated banks, highlighting the risk mitigation benefits of sector specialization (Hsieh, Chen, Lee, & Yang, 2013; Jahn, Memmel, & Pfingsten, 2013; C.-C Lee, Hsieh, & Yang, 2014; Rossi et al., 2009).
Research by V V Acharya et al (2006) indicates that asset diversification does not necessarily enhance bank security, with no conclusive evidence supporting this link Banks are increasingly shifting toward more risky industries or business lines, which diminishes the advantages of diversification, as noted by Stiroh (2015) Risk-taking behavior is often driven internally by managers aiming for higher profitability through diversification into riskier assets Consequently, the relationship between diversification and banking risk remains ambiguous Boot and Ratnovski (2016) highlight that the combination of long-term relationship banking and short-term transactional banking can negatively impact the stability of relationship banking, limiting the risk mitigation benefits typically associated with diversification.
Asset diversification and bank performance
Research indicates that diversification positively impacts bank performance and efficiency by strengthening intermediation and reducing information asymmetries, making it a strategic approach for financial institutions Classical banking theories highlight that banks uniquely leverage customer information, suggesting that diversification is optimal from a financial intermediary perspective Studies by Berger, Hasan, & Zhou (2010), Boyd & Prescott (1986), and Diamond (1984) support the idea that diversification enhances bank income quality Additionally, diversification fosters increased competition and promotes financial innovation, contributing to a more dynamic banking sector.
Moreover, diversification allows credit institutions to benefit from cheaper monitoring, greater efficiencies, and more effective management skills (Drucker
Research by Puri (2009), Iskandar-Datta and McLaughlin (2007), Moudud-Ul-Huq et al (2018), and Tabak et al (2011) highlights the importance of foreign-owned asset diversification in banking A study conducted across six Asian countries found that banks with higher levels of foreign asset diversification demonstrate greater profit efficiency, emphasizing the role of international diversification strategies in improving bank performance.
L A Nguyen, 2018) In addition, it is suggested that asset diversification has a positive impact on banks' long-term performance (Baele et al., 2007).
Some studies indicate that diversification can negatively impact bank performance, favoring a focused strategy instead Corporate finance theory suggests that firms benefit from reduced costs and increased efficiency when concentrating on sectors where they have expertise (V V Acharya et al., 2006) A concentration strategy helps organizations eliminate agency issues and leverage management capabilities (P G Berger & Ofek, 1995; Jensen, 1986) Conversely, concerns about increased competition make some companies hesitant to pursue diversification (Winton, 1999), with research across various banking sectors—Italian, German, Brazilian, and European—supporting this viewpoint (V V Acharya et al., 2006; Mercieca et al., 2007) Empirical evidence also shows that asset diversification can reduce the technical efficiency of foreign banks (Elyasiani and Wang, 2012), increase costs and lower profits in Chinese banks (A N Berger, Hasan, and Zhou, 2010), and generate negative excess values (L Laeven and Levine, 2007) However, when banks' screening and monitoring abilities are accounted for, the adverse effects of diversification tend to diminish or disappear (Vazquez & Federico, 2015).
Research on the relationship between asset diversification and bank performance yields mixed findings, with some studies indicating positive or negative effects while others find no significant correlation (Hsieh et al., 2013) Many authors highlight that results are often unclear or vary depending on the specific time period and banks studied, with Maodos (2017) noting that the positive impact of diversification on profitability is not always consistent and depends on how banks implement diversification strategies Consequently, previous research conclusions remain inconsistent, and even studies by the same author can produce different results (A N Berger, Hasan, Korhonen, & Zhou, 2010) Experts emphasize that the relationship between bank performance and diversification is complex and non-monotonic, suggesting that effective management and operational strategies are more critical than mere diversification or concentration levels in determining future profitability.
Furthermore, the researcher also found that asset diversification only helps banks grow instantly, but lacks long-term efficiency (T L A Nguyen, 2018) Curi et al.
Asset diversification can enhance bank performance during consolidation periods, but its positive impact diminishes during times of economic crisis This aligns with previous research on US banks (Stiroh, 2004b) and a global sample analyzed up to 2008, which found no consistent positive effect over time (Beck, Demirgüç-Kunt, & Merrouche, 2010) The relationship between asset diversification and bank performance shifts sign before a crisis, indicating that diversification's benefits are context-dependent Despite a positive correlation between asset diversification and performance, these effects are not statistically significant during financial crises Foreign bank profitability varies when asset diversification is implemented during consolidation and pre-crisis periods but shows no significant influence during crises, suggesting that asset diversification's impact on bank performance is limited in turbulent times.
Summary
This chapter explores the relationship between diversification, bank risk, and performance, highlighting key theories such as Market Power Theory, Agency Theory, Resource-Based View, and Modern Investment Portfolio Theory These theories provide essential insights into how diversification influences bank stability and profitability, emphasizing the role of market power, agency relationships, and resource capabilities Understanding these foundational concepts helps explain the impact of diversification strategies on reducing risk and enhancing overall bank performance within the financial industry.
Based on the literature review in theoretical and empirical studies in previous sections, this dissertation builds the hypotheses to implement and answer the research objectives and questions (see Figure 2.1).
Source: Author’s calculationThe next chapter, Chapter 3 presents research data and methodology.