Operational Diversification and Stability of Financial Performance in Indian Banking Sector: A Panel Data Investigation

Abstract

Reforms in Indian banking sector and subsequent entry of domestic and foreign private banks have enhanced competition in the sector significantly raisings the possibility of fluctuations in financial performance of the banks. As a strategic response to these changing market conditions, many of the banks have followed the route of diversifying their operations to reduce the instabilities in their financial performance. In this perspective, the present paper is an attempt to examine the impact of the strategy of operational diversification on stability in financial performance of the banks. The paper uses panel data regression techniques for a set of 59 banks over the period from 1995-96 to 2007-08. It is found that the banks with greater extent diversification of operations suffer from the problem of larger fluctuations in financial performance possibly due to their failure in deciding the right areas of diversification and its optimum extent. Future research should aim at addressing these issues as over-diversification of operations or diversification into areas of noncore competencies may affect stability of financial performance adversely as well as may create conflicts across the regulators in defining their jurisdiction, particularly when the areas of operations overlap.

Keywords: Operational diversification, financial performance, stability, banks, India