Real sector consequences of bank diversification: evidence across US industries and states

This paper aims to examine the consequences of banks asset, funding and income diversification on regional economic stability in the USA by using data on all 50 states and Washington, DC for 17 industries and their disaggregated constituent categories.

By using a panel dataset across industries and states in the USA, the author explains sector-specific state-level variation in average GDP growth during 2008-2009 using the average bank diversification during 2006-2007, as well as pre-crisis level growth rates in GDP, multifactor productivity in each industry and pre-crisis period state-specific key banking conditions.

The author finds banks’ pre-crisis level of diversification to have a positively significant impact on sector-specific state-level GDP growth during the Great Recession. The positive impact of banks diversification activities on industry-specific output growth across states is most pronounced for funding diversification.

The results indicate that bank diversification activities could be used as a measure to resuscitate an ailing economy and enhance the resilience of the real sector to financial sector distress. The same applies for banks capitalization and profitability.

Although a burgeoning body of literature has examined different aspects of banks income diversification, focusing mainly on its effects on risk and returns, the real sector implications of bank diversification activities have been rarely studied, especially in the US context.