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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 .
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“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
112
(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).
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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.
117
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…
118
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
130
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.