Revenue diversification and insolvency risk: evidence from banks in emerging economics

Are there significant benefits of revenue diversification for banks in emerging economies? This paper investigates the impact of revenue diversification on insolvency risk in emerging economies as measured by the distance to default. Using a panel dataset of 322 listed banks across 22 countries and a new methodological approach (Systems Generalized Method of Moments estimator), we provide the first empirical evidence of the impact of (i) the observed shift towards non-interest income and (ii) diversification within interest and non-interest generating activities on insolvency risk. Our core finding is that diversification across and within both interest and non-interest income generating activities decreases insolvency risk. Moreover, we find diversification gains remain even though increased reliance on non-interest income lowers risk adjusted profits. By extension, our results have significant strategic implications for bank managers and supervisors in emerging economies.