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Net economic gain from diversification in the commercial banking industry

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During the last two decades, banks have acquired new powers to expand the scope of their operations. Given these opportunities, the evolving structure of the banking industry will depend largely on the extent of product-mix efficiency available to commercial banks. Those banks that adopt the most efficient product mix are in a position to exploit the relative cost advantages and to continue to grow. This empirical study provides comprehensive measures of the economic impact of diversification in the commercial banking industry. Diversifying a bank's operation is not a costless endeavour. The empirical findings suggest, ceteris paribus, that while diversification reduces technical efficiency by approximately 28%, it improves allocative efficiency by 4% and increases scale efficiency by 39%. The overall economic gain from diversification in the commercial banking industry is approximately 1%. The optimal strategy of a commercial bank is to internalize market transactions to the margin where benefits are equal to cost. The empirical results suggest that this strategy is generally sustained in the commercial banking industry.

Document Type: Research Article


Publication date: August 1, 1999

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