Diversification of the Banking Firm

Diversification of banks and bank holding companies into nonbank product lines may reduce the risk to banking returns or cash flows provided appropriate portfolio conditions are satisfied. This study of bank and nonbank financial-service firms and nonfinancial corporations over the 1966–1985 period finds evidence consistent with the proposition that individual banking firm risk may be reduced through selected product-line diversification, particularly in the insurance and data processing fields. Moreover, there is evidence of less cash-flow sensitivity of selected nonbank product lines to exogenous economic and financial-market variables compared to banking firms. While public policy continues to insulate banking firms from most nonbank product and service lines, the potential benefits of risk reduction suggest that a careful review of current policy is needed.