Diversification, Organization, and Efficiency: Evidence from Bank Holding Companies

We use a portfolio-simulation technique to estimate the value added from di- versification by bank holding companies. Using a sample of 412 multi-bank bank holding companies (MBHCs) from 1990 to 1994, we construct pro forma benchmark portfolios for each MBHC composed of shares of single banks, weighted to correspond to the MBHC's distribution of activities. We then compare the performance and characteristics of the MBHCs to that of their pro forma benchmarks. Diversification through the holding com- pany structure does appear to bring certain benefits: the MBHCs hold less capital and engage in more lending, on average, then their pro forma benchmarks. However, these desirable characteristics do not translate into higher profits, implying some organizational inefficiencies inherent in the holding company structure. This suggests that banks should be allowed to realize the benefits of diversification without limiting them to a particular organizational form.

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