The impact of performance, liquidity and credit risks on banking diversification in a context of financial stress

Abstract

Purpose

The purpose of this paper is to examine the relation “diversification-risk-performance” for Islamic and conventional banks in different financial stress levels. Also, it aims to investigate the impact of the structure of board directors, macroeconomic variables and banking specific factors on banking diversification.

Design/methodology/approach

The authors use generalized least squares regressions to examine the impact of banking specific, macroeconomic and governance variables on investment diversification of 66 Islamic and conventional banks during the period from 2006 to 2018. In addition, this study uses panel threshold regressions to study the impact of banks’ profitability and risks on investment diversification in different financial stress levels.

Findings

The findings show liquidity risk, performance, credit risk and capitalization ratio are significantly related to investment diversification of Islamic banks. On the other hand, liquidity and credit risks, capital to total assets ratio and size have a significant influence on investment diversification of conventional banks. In addition, the diversification strategy of Islamic banks is less sensitive to macroeconomic indicators. As regards to governance variables, the results suggest that the board size, the executive directors and the foreign directors have significant impact on the investment diversification in Islamic banks. On the other hand, chief executive officer duality and foreign directors affect significantly the investment diversification of conventional banks. This study also found that financial stress enables us to develop a better understanding of the relation “performance-risks and diversification.”

Practical implications

It is expected that the findings of this paper can be used by Islamic and conventional banks in Gulf Cooperation Council (GCC) region that seek to manage the diversification strategy by reducing risk-taking and maximizing profitability. This study suggests that bank managers should consider the level of financial stress during the development of diversification strategy. It provides a better understanding for bank managers about the effect of bank specific and macroeconomics factors as well as governance variables on diversification.

Originality/value

This study focuses on providing an extension of the existing literature by studying the impact of financial stress indices on the relation between banks’ risk-performance and investment diversification for Islamic and conventional banks in the GCC region.

Citation

Gafrej, O. and Boujelbéne, M. (2022), "The impact of performance, liquidity and credit risks on banking diversification in a context of financial stress", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 15 No. 1, pp. 66-82. https://doi.org/10.1108/IMEFM-09-2020-0488