Does credit diversification drive banks’ cost of intermediation? An empirical exploration

Abstract

The disparity between the interest rates on loans and deposits is a widely used indicator of how expensive financial intermediation is for a community. The nations which reflect lower intermediation costs have higher levels of banking penetration and financial development (Gupta et al., 2021). This research examines the impact of credit diversification strategy on cost of intermediation of the Indian commercial banks. Additionally, our study shows the moderating role of bank ownership in this nexus. The static and dynamic estimation of panel data of the banks during the period 2014 to 2020 are carried out to analyse this relationship. Our baseline results refute the findings of Bustaman et al. (2016) and Huynh and Dang (2021) and indicate that the more diversified a bank’s credit portfolio, the higher its cost of intermediation. Besides, the results reflect the effect of credit diversification in inflating the cost of intermediation is less severe for the banks with public ownership. Thus, this research emphasizes while promoting a diversified strategy, regulators and bank managers should carefully evaluate the positive impact of credit diversification on banks’ cost of intermediation with a caution that the positive impact is more severe for private sector banks.