Bank Specialization and Credit Risk: Evidence from Global Financial Crisis Shock

Authors: Lemu Abebe Geleta

Abstract:

This paper uses global financial crises as an external shock to investigate the impact of bank specialization and credit risk. While prior research has provided theoretical support for the importance of specialization in bank credit risk, our study focuses on specialization and stability after the financial shock. Based on a sample of lead banks involved in syndicated loans in the USA region from 1993 to 2022, we find that bank specialization is significantly related to credit risk. Traditional portfolio theory suggests that bank diversification can mitigate idiosyncratic shocks on loan portfolios, implying that specialized banks may exhibit lower stability than diversified counterparts. However, concerns have arisen regarding specialization into non-lending activities, potentially isolating banks from lending and developing credit risks. Our findings suggest that banks specializing in sectors are adversely related to credit risk pre-crisis and post-crisis, aligning with theories advocating sectoral specialization over portfolio bank specialization. Overall, this research contributed to understanding the dynamics between bank specialization, credit risk, and external shocks like the global financial crisis, offering insights into financial stability and risk management.

Keywords: bank specialization, financial crisis, credit risk, difference-in-differences, Herfindahl Hirschman index