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Chapter 5

DETERMINANTS (MOTIVES) FOR DIVERSIFICATION IN

BANKS

A diversification strategy is pursued when firms have opportunities embedded

in market structures and technology as well as opportunities for growth in the firm’s

basic business (Chandler, 1977). The motives for diversification of banking sector

could be economic and revenue benefits like economies of scale and scope,

organizational effectiveness and efficiency, funding cost, risk reduction, economizing

on capital, making large deals and other motives (private managerial benefits, defense

against takeovers, etc). Various authors in earlier studies have found that diversified

banks enjoy competitive advantages relative to non-diversified specialized

counterparts such as:

• Economies of scale and scope arising from their larger size (Horst, 1972);

• Managerial and marketing expertise (Servan-Schreiber, 1968);

• The acquisition of market power and the creation of market entry barriers are

central motives for the diversification of business activities (Ramanujam &

Varadarajan, 1989; Markides, 1995);

• Utilization of super technology owing to their heavy emphasis on research and

development (Gruber, Metha and Vernon, 1967);

• Financial strength, portfolio diversification, risk reduction and access to financial

sources (Lloyd, Gadstein and Rogow, 1981);

• Other theories offered motives, which go beyond the direct economic advantage

like credibility with customer and competitors, Growth abroad in order to survive

at home and “Follow the Customer” (Eiteman and Stonehill, 1979);

• Narrowing profit margins in banks and insurance companies call for new sources

of income by cross selling (Voutilainen, 2004);

• Changing customer behaviour such as one-stop shopping requires cooperation

between all financial service providers (Voutilainen, 2004);

• Increased economic benefits through more efficient utilization of business

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resources across multiple markets (Clarke, 1985);

• Improved debt capacity, reduce the chances of bankruptcy by going into new

product/ markets (Higgins and Schall, 1975; Lewellen, 1971) and

• Improved asset deployment and profitability (Teece, 1982; Williamson, 1975);

In the Figure 5.1, most common motives for diversification as cited in (Dautwiz

2009) are given.

Fig 5.1 An Overview of diversification motives

Diversification as a

rational strategic

decision

Financial economic motives Risk minimization

Industry economic motives Access to markets

Entry barriers

Resource-oriented motives Economies of Scale

Synergies/Resource leverage

Agency theory motives In transparency

Income stimulation

Empire building

Transaction cost theory motives Internal capital market

Vertical Integration

Source: Trautwein (1990) as cited in (Dautwiz 2009)

Banks’ diversification has represented an important way of increasing the

volume of revenues and offsetting the reduction of interest margins triggered by

financial disintermediation (Vennet, 2000). In the literature, the main factors from

which banks’ gain in efficiency and profit related to diversification are identified, on

the one hand, in the spread of fixed costs (physical and human capital) over a wider

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set of products and on the other hand, in the complementary relationships in

consumption arising from a reduction in consumer search and transaction costs (Landi

and Venturelli, 2001).

The main aim of this chapter is to study the factors that have driven banks in

India to diversify their operations into nontraditional products and services to

generate more income from sources other than interest income. Various determinants

and motives of diversification are grouped in two categories i.e, the external

determinants and internal determinants. These determinants have been extracted from

various earlier studies (Berger et. al 1999; Schmidt et al, 1998; Landi and Venturelli,

2001 etc.).

External Determinants

• Regulations, laws and economic conditions, which include financial

liberalization and removal of constraints (Vernon, 1966, Kindleberger, 1969).

• Globalization phenomenon and harmonization with international standards (for

example, Basel I& Basel II) and others are related to the circumstances in the

banking industry itself (for example, the degree of concentration and excess

energy) (Vernon, 1966; Horst,1972)

• Dynamics of bank competition (DeYoung and Rice, 2003)

• Information and communication technologies (Gruber, Metha and Vernon,

1967; Eiteman and Stonehill 1979)

• Economies of scale and scope (Horst, 1972)

• Disintermediation in banks (Gultekin, Gultekin and Penati, 1989)

Internal Determinants

• Synergy and growth

• Customer relationship

• Risk reduction

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• Changing Income pattern of banks

• Cost reduction

• Other determinants and motives like managers personal motives, shareholders

motives etc.

5.1 External Determinants

External determinants include macroeconomic factors that have direct or

indirect influence on banks decision to diversify. Innovation in technology, increased

customer sophistication, regulatory changes, market globalization and reduced

multinational trade barriers are a few of the factors influencing banks decision to

diversification (Goddard, Molyneux, Wilson & Tavakoli, 2007). The group of Ten

Report (2001), highlights three major external factors creating pressure for change in

the financial service industry namely deregulation, technological advances and

globalization of the market place. Major external factors affecting banks decision to

adopt diversification are discussed as follows:

Regulations, Laws and Economic Conditions

Although the concept diversification itself has relatively ancient roots (in a

number of countries, there were financial groups that have been selling financial

products and insurance for a long time), financial conglomeration has only blossomed

into a major global phenomenon in the last decade (Lafferty Business Research,

1991). The banking industry has evolved from a sheltered business to a more dynamic

and more competitive sector (Verweire, 1999). The scope of banking activities in US

banking system has been historically limited and the regulatory environment still

prohibits the full integration of banking and insurance activities at large scale. With

the repeal of the Glass Steagall Act, in the United States, commercial banks’ has

stimulated diversification and expansion of the power of commercial banking

conglomerates in the securities industry (Landi and Venturelli, 2001). These changes

have induced US banks to diversify from core business to generate more income from

other interest income. Disintermediation, globalization, deregulation especially in the

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European Union and Japan and the application of new information technologies have

fundamentally disturbed the sector and induced the trend towards diversification of

banks (Verwiere 1999).

In Indian banking sector, to overcome these constraints, a series of financial

and economic reforms were introduced as per the report on various committees like,

the Report of the Committee on the Financial System (Chairman: Shri M.

Narasimham), in 1991; Report of the High Level Committee on Balance of Payments

(Chairman: Dr. C. Rangarajan) in 1992; and the Report of the Committee on Banking

Sector Reforms (Chairman: Shri M. Narasimham) in 1998. Reform measures were

initiated and sequenced to create an enabling environment for banks to overcome the

external constraints which were related to administered structure of interest rates,

high levels of pre-emption in the form of reserve requirements and credit allocation to

certain sectors (Reddy, 2005). In order to enhance competition in Indian banking

sector, foreign direct investment in the private sector banks is allowed up to 74 per

cent and also private shareholding in public sector banks were encouraged. The share

of the public sector banks in the aggregate assets of the banking sector has come

down from 90 per cent in 1991 to around 75 per cent in 2004 (Reddy, 2005). The

share of wholly Government-owned public sector banks (i.e., where no diversification

of ownership has taken place) have sharply reduced to 10 percent from about 90 per

cent of aggregate assets of all commercial banks during the same time period.

Diversification of ownership has resulted into improved efficiency, better

performance and greater market accountability. These reforms were also aimed at

improving regulatory framework and supervisory practices in line with the best

practices elsewhere in the world. The minimum capital to risk assets ratio (CRAR)

has been kept at nine per cent i.e., one percentage point above the international norm

and secondly, the banks are required to maintain a separate Investment Fluctuation

Reserve (IFR) out of profits, towards interest rate risk, at five per cent of their

investment portfolio under the categories ‘held for trading’ and ‘available for

sale’(Reddy, 2005).It was prescribed at a time of falling interest rates and banks were

realizing large returns out of their treasury and other activities .

111

“The financial sector in India has undergone significant liberalization in all

the four segments - banking, non-banking finance, securities and insurance and each

of these sectors has grown significantly accompanied by a process of restructuring

among the market intermediaries. The financial landscape is increasingly witnessing

(i) entry of some of the bigger banks into other financial segments like merchant

banking, insurance, etc. which has made them financial 'conglomerates'; (ii)

emergence of several new players with diversified presence across major segments

and (iii) possibility of some of the non-banking institutions in the financial sector

acquiring large enough proportions to have a systemic impact”- Report of the

Working Group on Monitoring of Financial Conglomerates,2004.

Globalization phenomena

The emergence of modern foreign exchange banking brought about by the

thriving of global inter-bank networks based on correspondent relationships, the

relative decline of traditional techniques and the emergence of financial innovations

in international liquidity management, such as over drafts, telegraphic transfers and

finance bills (Nishimura, 1971). Large banks from financially advanced,

industrialized Europe reacted to epoch-making shifts in communication technology,

international trade and demand for capital by sovereign and private borrowers by

rapidly expanding their cross-border and cross-currency business (Cameron, 1991).

At global level, banking activities have become more uniform inspite of the

differences in across countries, structures, domination and regulatory framework.

International characteristics of bank intermediation include assets and liabilities that

can be either cross-border (claims on foreigners denominated in domestic currency),

or cross-currency (claims on residents denominated in foreign currency), or both

(claims on foreigners denominated in foreign currency) (Bryant, 1987). Banks are

taking critical decisions for engaging in multinational banking (MNB) through

foreign direct investments (either greenfield or through acquisitions) in order to locate

part of their activities in a foreign country. Banks are attracted there by the existence

of externalities in the form of economies of scale either external to markets

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(infrastructures, human capital, regulatory attitude of monetary authorities) or internal

to markets—i.e. the existence of deep, liquid and informational efficient markets

thanks to a high number of participants (Davis, 1990).

Diversification in banking sector has emerged during last two decades in

response of globalization at the world level in order to harmonize with international

standards (for example, Basel I& Basel II) and others are related to the circumstances

in the banking industry itself (for example, the degree of concentration and excess

energy). Commercial banks in India have started implementing Basel II with effect

from March 31, 2007.

Dynamics of bank Competition

Banking industry deregulation fosters competition between banks, non-banks

and financial markets by removing restrictions that stunt the evolution of the banking

system, constrain the efficiency of the financial product markets (DeYoung and Rice,

2003). In response to these competitive threats and opportunities many banks have

embraced the new technologies that drastically altered their production and

distribution strategies and resulted in large increase in non-interest income (DeYoung

and Rice, 2004). The impact of deregulation on banking competition and the

consequent need for banks to restructure have been aggravated by a situation of

excess capacity related to the growth of the financial markets (Landi and Venturelli,

2001). First, during the 1990s, India underwent liberalization of the banking sector

with the objective of enhancing efficiency, productivity and profitability (Government

of India, 1991). Second, the banking sector underwent an important transformation,

driven by the need for creating a market-driven, productive and competitive economy

in order to support higher investment levels and accentuate growth (Government of

India, 1998). Banking industry is also facing stiff competition from numerous non-

banking competitors like mutual funds, securitization and other finance companies.

Compulsions arising out of increasing competition, as well as agency problems

between management, owners and other stakeholders are inducing banks to look at

newer avenues to augment revenues, while trimming costs (Jalan, 2001).

113

Information and Communication Technology

Information and Communication Technology products in use in the banking

industry include Automated Teller Machine, Smart Cards, Plastic Money, Telephone

and Electronic Banking, MICR, Electronic Funds Transfer, Electronic Data

Interchange etc. Technological innovation and their applications in offering products

and services have revolutionized the operation of whole banking sector. New

technology allowed the introduction of new services and in turn, new retail bank

products brought the bank service away from the branch and closer to the customers

by delivering customer information at the point of sale. (Lazo and Wood, 2001). The

application of information and communication technologies has resulted in online

banking, greater accuracy of records, convenient and prompt customer services.

Information Technology (IT) is the automation of processes, controls, and

information production using computers, telecommunications, software and ancillary

equipment such as automated teller machine and debit cards (Khalifa, 2000).

Below, contribution of technological progress in making banks to diversify

their operation is given briefly; -

• Innovations in information and communications technologies (ICT) reduced

price differentials in geographically distant markets (Lazo and Wood, 2001).

• IT applications have led to enhanced speed, quantity and quality of service and

information communication about cross-border transactions as well as record

keeping.

• IT revolution assists in mass delivery of retail financial services via consumer

oriented approach.

• Advent of digital communications technologies and networks, facilitate

integration of data resources and networks.

• The integration of services around digital networks (ISDN) and greater use of

electronic data interchange (EDI) protocols were at the heart of new

distribution channels such as electronic fund at point of sale terminals

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(EFTPOS), telephone transfer systems and smart cards (Lazo and Wood,

2001).

• Technology ensured border-less services via VISA and MasterCard

International networks.

So, advanced information technology has fundamentally changed the strategic

landscape. Internet has reduced the importance of geography in the production of

financial services and the maintenance of financial relationships. Moreover, the cost

of delivering the financial services has greatly reduced with the Internet.

Economies of scale and scope

Banks aimed at achieving economies through cross-selling of different

financial products to the larger customer base of the combined entity, utilizing new

distribution channels to make more efficient use of the fixed cost associated with the

banks branching (Pasiouras et al., 2005). The ability to provide diversified financial

services was intended to foster economies of scale and scope.

Economies of scale exist if, assuming a constant product mix, a bank faces

declining average cost as its size expands (Vennet, 2002). Economies of scale occur

when by increasing the size of business and operations a firm produces output at a

lower cost. Benefits from increased scale can be reduced unit costs; higher per unit

revenues; improved access to capital markets; the ability to make larger loans or offer

broader product lines; the ability to attract and retain high quality managers; reduced

portfolio risk from diversifying into new geographic markets; and network benefits

from integrating systems of branches and ATMs that cover different geographic areas

(Young and Hunter, 2003). For examples, banks can derive economies of scale

through physical branch distribution network, infrastructure software and electronic

distribution systems. Two major development financial institutions (DFIs) – ICICI

and IDBI converted themselves into a commercial bank in 2002 and 2004

respectively, primarily to tap into low-cost deposit funds and diversify their asset

structure.

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Economies of scope mean that the joint production of two or more goods is

accomplished lowering average cost (Cost per unit) than producing them separately.

For example, banks that offer both commercial and investment services to their

clients could reduce costs and achieve economies of scope if various departments

share information, transactions systems and monitoring costs. Factors of production

must meet three conditions for the existence of economies of scope.

• increasing returns (or indivisibilities) to scale,

• transaction costs preventing an efficient market in these factors,

• limits on obtaining increased factor utilization by expanding the output of any

single end product (Rumelt, 1982).

Economies of scope are mainly achieved through product diversification

(ability to provide one stop shopping). Economies of scope may derive from the

potential for lower search, information, monitoring and transaction costs; negotiating

better deals because of increased leverage and lower product prices in a more

competitive environment (Claessens, 2002). Economies of scope may arise both from

the production and consumption of financial services (Saunders and Walter, 1994).

With regard to international conglomeration, the two major reasons, economies of

scope and size aimed principally at increasing revenue through cross-selling and

strong brands that is attractive to large international clients (Pariouras, Tanna and

Zopounds, 2005).

Disintermediation in the banking sector

One of the most significant force forcing banks to diversify towards non-

traditional banking business has been the disintermediation in the banking sector.

Both on the assets, as well as on the liabilities side, commercial banks are faced with

an erosion of their intermediation function. On the assets side of the bank’s balance

sheet, credit institutions are confronted with the replacement of straight bank loans by

market-determined sources of financing (Verweire, 1999). On the liabilities side,

there is a substantial outflow of deposits to a wide range of new financial products

116

offered by companies of different sectors, such as life insurance companies (Vander

Vennet, 1994). This disintermediation, in combination with new capital adequacy

rules, has put an increased pressure on the banks’ profitability. All fee income was

therefore, a welcome source of diversification (Berghe and Verweire, 1998).

So as a result of deregulation and intensified competition, banks have

diversified themselves to emerge as financial conglomerates. Emergence of banks as

financial conglomerates can be seen as the result of a diversification strategy with the

aim of providing all types of financial services under one roof. Integration and cross

selling of financial services may result in generating consolidated revenue. Banks can

use existing client relationships more profitably by offering a wider package of

financial services.

5.2 Internal Determinants of Diversification in the banking sector in India

Internal determinants include bank specific factors, which motivate banks to

diversify their operations towards non-traditional products and services to generate

more revenue from other sources.

Empirical Analysis of Internal Determinants of Banks

To study the internal determinants for diversification in banks and their

significance in making banks decision to diversify their operations, factor analysis

technique has been used. For the aforesaid purpose, various internal motives are

analyzed on the basis of primary study. To analyze the motives for diversification of

banks, twenty-four variables have been used for the factor analysis. These variables

have been derived from various earlier studies conducted in banking sector in India

and abroad. See (Silverman, Murray, Castaldi and Richard, (1992); Pulley, Berger

and Humphrey, (1993); Johnston, Jarrod and Madura, (2000); Farisell and Noreous,

(2002)). Factor Analytic technique has been used to determine the factors in terms of

motives driving banks to diversify their operations and services.

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Analysis of Determinants (motives) based on primary data

In this section, an explorative study is done on the basis of primary data. As

mentioned in third chapter of research methodology, based on the literature, a

standardized questionnaire was used to collect information required for analyzing the

various motives for diversification in banking sector in India. The opinion expressed

in questionnaire regarding motives for diversification on twenty four reasons were

measured on a five point scale (Likert scale) ranging from 5 to 1 depending on the

importance attached to each variable Table 5.1. For example, “Very Important” was

ranked 5 followed by “Important” with value 4, “Neither Important nor unimportant”

with 3, “Less important” with 2 and “not important” with 1.

Table 5.1: Determinants (Motives) For Providing Diversified Services (List of

Variables).

S. No Variables

V501. To access new sources of deposits

V502. To acquire new marketing capabilities

V503. To apply corporate management skills to new businesses

V504. To escape the systematic risk of a single market

V505. To broaden the customer base

V506. To save costs through cross-selling of activities

V507. To expand sales to existing customers

V508. To increase earnings per share

V509. To increase growth

V5010. To increase profitability

V5011. To increase shareholders wealth

Contd…

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S. No Variables

V5012. To keep technology up-to-date

V5013. To obtain new loan customers

V5014. To position the bank to be competitive in the future

V5015. To reduce costs

V5016. To respond to internet services of competitors

V5017. To retain existing customers

V5018. To reduce risk by operating in a number of different areas

V5019. To supplement revenues

V5020. To gain economies of scale and economies of scope

V5021. To gain market power

V5022. To reduce monitoring costs

V5023. To meet diversification moves of domestic competitors

V5024. To meet changing customer perceptions

Initially, the inter correlation among the variables were calculated. The correlation

matrix, (Table 5.2) revealed the following variables, which showed greater correlation.

1. Expansion of sales to existing customers with broadening the customer base

2. Meeting diversification moves of domestic competitors with increase in growth

3. Gaining market power to position the bank with to remain competitive in the

future

4. Meeting diversification moves of domestic competitors with reduction in costs

5. Meeting changing customer perceptions with supplementing revenues

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Table 5.2: Correlation Matrix for Determinants (Motives).

I Correlation Matrix

V501 V502 V503 V504 V505 V506 V507 V508 V509 V5010 V5011 V5012

V501 1

V502 -0.25 1

V503 -0.26 0.236 1

V504 -0.06 0.394 0.3495 1

V505 -0.04 0.223 -0.261 0.1 1

V506 -0.07 0.455 0.2441 0.3 0.11 1

V507 0.179 0.167 -0.1 0.2 0.7 0.02 1

V508 -0.26 -0.41 -0.146 -0.3 0.06 -0.3 -0.123 1

V509 0.02 0.045 -0.027 0.4 0.31 -0.3 0.392 -0.1 1

V5010 0.402 0.038 -0.058 -0.2 0.03 0.26 -0.14 -0.1 -0.39 1

V5011 -0.14 -0.01 0.0698 -0.3 0.07 0.17 0.191 0.2 -0.3 -0 1

V5012 0.22 -0.14 -0.454 -0.2 -0.2 -0.4 0.002 -0 -0.07 0.18 0.148 1

V5013 0.034 -0.02 -0.086 -0.2 -0.3 0.35 -0.24 -0.3 -0.48 0.34 0.023 0.3

V5014 0.098 0.223 0.0371 0.4 0.22 0.18 0.162 -0 0.2 -0.2 0.066 0.1

V5015 0.29 -0.27 -0.023 0.3 -0.1 0.07 0.021 -0.3 0.14 -0.2 -0.04 0.1

V5016 0.204 -0.28 -0.486 -0.1 0.36 -0.4 0.337 0.3 0.13 -0.2 0.268 0.4

V5017 0.02 0.045 -0.027 0.4 0.31 -0.3 0.392 -0.1 1 -0.4 -0.3 -0.1

V5018 -0.5 0.405 0.1707 0.1 0.08 -0 -0.18 0 0.11 -0.3 0.12 -0.2

V5019 0.142 -0.3 -0.07 0 0.31 0.05 0.376 -0.2 -0.01 -0.3 0.095 -0.2

V5020 0.226 -0.47 -0.243 -0.2 -0.2 -0.3 -0.154 -0 0.14 -0.1 0.152 0.3

V5021 0.009 0.186 0.0858 0.4 -0.1 0.31 -0.079 -0.3 -0.02 -0.3 0.152 -0.2

V5022 0.291 -0.16 -0.206 0 0.45 0.21 0.655 -0.2 0.02 -0.1 0.318 0.2

V5023 0.4 -0.16 -0.009 0.3 0.14 -0.3 0.107 0 0.57 -0.1 -0.45 -0.2

V5024 0.004 -0.14 0.2209 0.2 -0.5 -0 -0.487 -0 -0.01 0.26 -0.2 0.2

Contd…

120

I Correlation Matrix V5013 V5014 V5015 V50 16 V517 V518 V5019 V520 V21 V22 V23 V24

V501

V502

V503

V504

V505

V506

V507

V508

V509

V5010

V5011

V5012

V5013 1

V5014 0.106 1

V5015 0.314 0.681 1

V5016 -0.24 0.087 0.002 1

V5017 -0.48 0.204 0.139 0.129 1

V5018 -0.4 -0.08 -0.34 -0.06 0.112 1

V5019 -0.02 -0.07 0.277 0.388 -0.01 -0.12 1

V5020 -0.04 -0.11 0.191 0.411 0.143 -0.19 0.1395 1

V5021 0.151 0.701 0.694 -0.15 -0.02 0.05 0.1395 -0.1 1

V5022 0.041 0.117 0.242 0.536 0.024 -0.4 0.6571 0.14 0.011 1

V5023 -0.18 0.472 0.527 0.012 0.467 -0.34 -0.0311 0.2 0.204 -0.1 1

V5024 0.156 -0.05 0.146 -0.36 -0.01 -0.09 -0.6065 0.17 0.031 -0.5 0.1522 1

121

The results of factor analysis have been shown in Table 5.3 and 5.4. Kaiser’s

criterion, considers factors with an Eigen value greater than one as common factors

(Nunnally, 1978).

Table 5.3: Eigen Values and Percentage of Variance (Determinants (motives))

Total Variance Explained Cumulative %

Component Initial Eigen values

Total % of Variance

V501 4.598098 19.15874 19.15874

V502 3.536704 14.73627 33.89501

V503 3.13924 13.08017 46.97518

V504 2.603624 10.84843 57.82361

V505 2.067032 8.612633 66.43624

V506 1.558196 6.492485 72.92873

V507 1.363662 5.681924 78.61065

V508 1.016091 4.233714 82.84436

V509 0.823989 3.433286 86.27765

V5010 0.670519 2.79383 89.07148

V5011 0.594361 2.476502 91.54798

V5012 0.544349 2.268119 93.81615

V5013 0.394896 1.645399 95.46157

Contd…

122

Total Variance Explained Cumulative %

Component Initial Eigen values

Total % of Variance

V5014 0.339444 1.414352 96.87585

V5015 0.331378 1.380743 98.2566

V5016 0.182277 0.759486 99.01608

V5017 0.101967 0.424863 99.44094

V5018 0.090056 0.375232 99.81618

V5019 0.031198 0.12999 99.94617

V5020 0.006974 0.029059 99.97523

V5021 0.005064 0.021099 99.99632

V5022 0.000882 0.003675 99.97523

V5023 0.005064 0.021099 99.99632

V5024 0.000882 0.003675 100

From table 5.3, number of factors are to be extracted. Since the Principal

Component analysis model has been used, only those factors whose eigen value is greater

than unity are selected. The eigen value are shown in Table 5.3. From this table, eight

factors are extracted. Total variance accounted for eight extracted factors is 82.84% and

the remaining variances are explained by other factors.

Table 5.4 presents the rotated factor matrix. All the factor loadings that are greater

than .50 (ignoring the sign) have been considered for further analysis.

123

Table - 5.4 : The Rotated Factor Matrix, The Final Statistics(Determinants

(motives))

Rotated Component Matrix

Component

1 2 3 4 5 6 7 8

V501 0.055718 0.118598 0.488492 0.251553 -0.34468 0.428473 0.098021 0.527249

V502 0.130139 0.219727 0.161473 -0.02104 0.410173 -0.73018 0.029219 0.259361

V503 -0.07036 -0.22508 -0.22647 0.007604 0.737902 0.028863 0.379248 0.087873

V504 0.369192 0.081608 -0.10889 0.427988 0.367792 -0.51997 0.322626 0.336908

V505 0.049284 0.872144 0.095419 0.136438 -0.04925 -0.18539 -0.02797 -0.10116

V506 0.232391 0.132176 0.299123 -0.42998 0.509332 -0.10956 1.81E-05 0.302569

V507 -0.01346 0.857759 -0.03532 0.110941 0.041761 0.101456 0.276497 0.075574

V508 -0.15439 0.009912 -0.15076 -0.03971 -0.10696 0.065515 -0.09677 -0.90833

V509 -0.17506 -0.08127 0.925447 -0.07865 0.059385 0.06143 -0.00211 0.042723

V5010 -0.17506 -0.08127 0.625447 -0.07865 0.059385 0.06143 -0.00211 0.042723

V5011 0.091289 0.175905 -0.08319 -0.74529 -0.1271 -0.03599 0.424325 -0.2648

V5012 0.24203 0.008369 0.079319 -0.03647 -0.05073 0.08237 0.872243 0.109887

V5013 0.284139 -0.54592 0.377055 -0.42855 0.136779 0.320924 -0.34804 0.154798

V5014 0.120281 0.205655 0.029217 0.883135 0.08127 -0.02521 0.126933 -0.16588

V5015 0.817976 -0.0632 -0.05448 0.122847 -0.05858 0.45021 0.019699 0.149659

V5016 -0.0313 0.443789 -0.17823 -0.07558 0.172411 0.087092 -0.70495 -0.11744

V5017 0.394484 0.661917 -0.23285 0.286158 -0.05612 -0.11334 0.268631 -0.07072

V5018 -0.07453 -0.06932 -0.41221 -0.08421 0.012299 -0.79242 -0.105 -0.01292

V5019 0.031165 0.480662 -0.40101 -0.18653 -0.1573 0.43206 -0.12973 0.570695

V5020 -0.01071 -0.27441 -0.11437 0.01677 -0.70065 0.25235 0.278799 0.125549

V5021 0.88733 -0.08516 -0.16119 -0.12597 0.100284 -0.06447 0.093522 0.212124

V5022 -0.73589 0.1152 0.216283 -0.31283 0.081533 0.143607 -0.06661 -0.14579

V5023 0.405124 0.043651 0.035382 0.787325 -0.07434 0.295162 0.01473 -0.09803

V5024 0.062325 -0.75297 0.27142 0.232966 0.098914 -0.00791 0.306662 -0.10329

124

The twenty-four variables from the tables were then loaded on the eight factors

respectively as shown in table 5.4. Greater a factor loading of a variable greater is the

chances of the factor being named after these variables (Arora and Malhotra, 1999).

Naming of the factors (Table 5.5) has been done on the basis of the size of factor loadings

of the variables.

Table 5.5: Factors for Diversification of Banks and their score (Determinants

(motives))

Factor

Number

Factor Naming Variables Score

1 Cost Management

Motive

V5015.To reduce costs

V5021. To gain market power

V5022. To reduce monitoring cost

0.818

0.888

-0.736

2. Customer Retention

Motive

V505. To broaden customer base

V07. To expand sales to existing

customers

V5013. To obtain new loan customers

V5017. To retain existing customers

V5024. To meet changing customer

perception

0.872

0.858

-0.545

0.662

-0.753

3 Growth Motive V509. To increase growth

V5010. To increase Profitability

0.925

0.625

4. Competition Motive

V5011. To increase shareholder wealth

V5023. To meet diversification moves of

domestic competitors

-0.745

0.787

125

V5014. To position the bank to be

competitive in the future

0.880

5. Realizing

Economies Motive

V503. To apply corporate management

skills to new businesses

V5020. To gain Economies of scale and

Economies of scope

V506. To save cost from integrating

particular activities

0.738

-0.701

0.510

6. Risk Reduction

Motive

V502. To acquire new marketing

capabilities

V5018. To reduce risk by operating in a

number of different areas

V504 To escape the systematic risk of

a single market

-0.730

-0.793

-0.520

7. Optimal use of

Technology Motive

V5012. To keep technology up-to-date

V5016. To respond to Internet services

of competitors

0.873

-0.705

8. Financial Motive V501. To access new sources of

deposits

V508. To increase earnings per share

V5019. To supplement revenue

0.528

-0.909

0.571

126

Further, in order to find out significance level of factors, the factor wise average scores

(from the five point Likert scales) are calculated and accordingly ranking is done. The

factors have been ranked on the basis of factor wise average scores has been categorized

as follows in Table 5.6.

Table 5.6: Ranking and Average score of factors (Determinants (motives))

Factors Average scores Ranking

Cost Management Motive 3.46 5

Customer Retention Motive 4.34 3

Growth Motive 4.72 2

Competition Motive 3.40 6

Realizing Economies Motive 2.90 8

Risk reduction motive 3.72 4

Optimum use of Technology Motive 3.50 7

Financial Motive 4.74 1

Explanation of Table 5.5 and 5.6

The Financial Motive

The “Financial Motive” has ranked as the first important factor in banks

decision to adopt diversification move. “Financial motive” factor includes variables

V501 (to access new source of deposits), V508 (to Increase earning per share) and

V5019 (to supplement revenue). This finding indicates that the bank managers

perceive that financial motive is one of the major determinants for diversification.

The diversified firm has much greater flexibility in capital formation since it can

access external sources as well as internally generated resources (Lang and Stulz,

1994: Stulz, 1990).

127

The Growth Motive

The “Growth Motive” has ranked as second important factor in making banks to

diversify their operation and services. The “Growth Motive” factor includes variables

V5010 (to increase profitability) and V509 (to increase growth). Diversified firms can

employ a number of mechanisms to create and exploit market power advantages that are

largely unavailable to their more focused counterparts (Caves, 1991).

Customer Retention Motive

Customer Retention motive with value 4.34 has ranked as third important

factor. This scale groups five variables, V5017 (to retain existing customers), V5013 (to

Obtain new loan customers), V505 (to broaden customer base), V507 (to expand sales to

existing customers) and V5024 (to meet changing customer perception), which are

crucial to remain in the business. By offering a broader set of financial products than a

specialized bank, a diversified bank can develop “wider” and long-term relationships

with customers a source of scope economies. It gives the bank the opportunity to use the

information it collects by monitoring a firm’s checking account in various businesses

rather than just in lending decisions and use the reputation gained in offering one service

to recommend other services to their existing customers.

Risk Reduction Motive

Risk reduction motive has emerged as fourth important factor according to the

ranking, in the banks decision to diversify. This factor encompasses three important

variables V5018 (to reduce risk by operating in a number of different areas), V504 (to

escape the systematic risk of a single market) and V502 (to acquire new marketing

capabilities). The two most common forms of diversification are geographic and product

diversification. The former offers a reduction of risk, because the return on loans and

other financial instruments issued in different locations may have relatively low or

negative correlation. In a similar manner, the latter may reduce risk because the returns

across different financial services industries may have relatively low or negative

correlation.

128

The Cost Management Motive

The scale, describes the factor “The Cost Management motive” ranked as fifth

important factor in banks decision to diversify. Banks aim to generate high profits

through improving their efficiency and reducing cost in order to enhance the banks value

for bank equity-owners and executive officers. This encompasses all the revenue

enhancing motives. The presence of V5021 (to gain market power) under this factor

suggests that managers try to gain market power by diversification. Other variables under

this factor are V5015 (to reduce cost) and V5022 (to reduce monitoring cost) aimed at

reducing operating cost as well as monitoring cost of the banking business. The concept

of diversification is closely associated with the emergence of growing convergence

between the banking, insurance and investment sector.

Competition Motive

Factor 4, “Competition Motive” includes variables V5023 (to meet

diversification moves of domestic competitors), V5014 (to position the bank to be

competitive in the future) and V5011 (to increase shareholder’s wealth) are important

considerations in making banks decision to diversify. This motive traces back to

organizational rationality for diversification. In the era of globalization and intense

competition, a diversification strategy is chosen because the firm has no other choice.

It is ranked as sixth important factor in banks decision to diversify.

Optimal use of Technology Motive

Technology is transforming the banking and finance service industry. It has a

great influence on the core aspects of banking business i.e, information, processing and

delivery of financial services. This scale encompasses variables V5012 (to keep

technology up-to-date) and V5016 (to respond to internet services of competitors), which

exert a dominant pressure on banks to diversify. It is ranked as seventh important factor

in banks decision to diversify.

129

Realizing Economies Motive

Realizing Economies comes out eighth important factor as per the ranking,

in banks decision to diversify their operations and services. This factor includes

variables V5020 (to gain economies of scale and economies of scope), V503 (to apply

corporate management skills to new businesses) and V506 (to save cost from

integrating particular activities). Banks are diversifying to have possible gains such as

economies of scale and scope, increased debt capacity, increased efficiency of

resource allocation in internal markets and exploitation of firm-specific assets in

different markets.

Reliability study

Reliability refers to the accuracy and precision of a measurement procedure

(Thorndike, Cunningham, Thorndike, & Hagen, 1991). Table 5.7 lists the 8 factors, items

included in each factor, and factor alphas for the study sample (n=100).

Table 5.7 Factor structure and Reliability

Factor

Number

Factors Items Cronbach's

Alpha values

1 Cost Management Motive V5015, V5021, V5022 0.832

2. Customer Retention Motive V505, V507, V5013, V5017,

V5024.

0.779

3 Growth Motive V509, V5010. 0.818

4. Competition Motive V5011, V5023, V5014. 0.643

5. Realizing Economies V503, V5020, V506. 0.578

6. Risk Reduction Motive V502, V5018, V504 0.523

7. Optimal use of Technology V5012, V5016. 0.782

8. Financial Motive V501, V508,V5019 0.772

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Levels of Reliability

Cronbach's alpha (Cronbach, 1951) is extensively reported in the psychological

literature, in particular personality research, as an index of reliability (Bollen, 1989;

Cortina, 1993). The closer Cronbach’s alpha coefficient is to 1.0 the greater the internal

consistency of the items in the scale. Based upon the formula _ = rk /1 + (k -1)r] where k

is the number of items considered and r is the mean of the inter-item correlations the size

of alpha is determined by both the number of items in the scale and the mean inter-item

correlations (Joseph and Rosemary, 2003). Acceptable levels of reliability depend on the

purpose of the instrument. Acceptable reliability of instruments developed for research

purposes can be as low as 0.40(Suhr, 2006). In the above table, reliability of factor

namely risk reduction and realizing economies motive is less than 0.6 while in case of

other factors, it is above 0.6 except competition motive it is 0.64. The Cronbach's alpha

for first factor i.e,cost management motive is 0.832 which shows that acceptable

reliability is high. The Cronbach’s alpha for customer retention motive, growth motive

and financial motive factor are 0.779, 0.818 and 0.772 respectively. The Cronbach’s

alpha for optimal use of technology is 0.782.

Conclusion

So, to conclude, various external and internal determinants such as deregulation,

disintermediation, emergence of advanced technologies, along with the consolidation

wave in the banking sector have been instrumental in making banks to diversify their

operations. Banks decisions to diversify are often based on a combination of motives. On

the basis of primary study, eight types of determinants are found. These are financial

motive, growth motive, customer retention motive, risk reduction motive, cost

management motive, competition motive, optimal use of technology and realizing

economies motive. These motives are interrelated and not mutually exclusive. For

example, a desire to reduce the exposure to business risk is perfectly compatible with an

aim for growth.