How Does Bank Diversification Affect Efficiency? Insights of the Central Europe

This study empirically aims to investigate the influence of diversification on cost efficiency in the context of 10 Central European countries' (such as Hungary, Poland, Germany, Slovakia, Slovenia, Romania, Croatia, Serbia, Czech Republic and Switzerland) banks from 2011 to 2017 and employs two-stage least squares (2SLS) estimator as a methodological approach. It uses cost efficiency (EFF) and diversification (asset and income) as the main explanatory variables. Our baseline results show that asset and income diversification have a negative and significant effect on bank efficiency. Leverage (LEV) and the growth of gross domestic product (GDP) do not influence bank efficiency. From the bank control and macroeconomic level variables, it is found that one-year lagged cost efficiency (EFFLAG), assets diversification (AD), income diversification (ID), assets growth (AG), return on assets (ROA), return on equity (ROE), net interest margin (NIM) and rate of inflation (INFR) have a significantly negative relationship with the bank efficiency in the Central European countries. More importantly, both ID and AD tend decreasing the efficiency in the region.