Foreign bank diversification and efficiency prior to and during the financial crisis: Does one business model fit all?

Abstract

Diversified and focused business models may affect foreign bank efficiency differently. We investigate whether there is an optimal business model along three business dimensions—assets, funding and income—and which business model is optimal for foreign banks in a financial center. We apply recently developed non-parametric methods with bootstrap to estimate group efficiency, to test for differences across groups and finally to analyze the link between bank efficiency and diversification measures. Using Luxembourg bank data that include the financial crisis, we find that there is no unique business model. The most efficient business model appears to be a focused asset, funding and income strategy. Banks’ organizational forms play a role; branches may be preferable to subsidiaries prior to the financial crisis, whereas bank subsidiaries perform better than branches during the financial crisis. However, branches diversified in assets, funding and income exploit efficiency advantages during the financial crisis.