Shareholder Diversification, Bank Risk-Taking and Capital Allocation Efficiency

Using the entire universe of Bankscope and Amadeus Top 250,000 we construct the portfolios of shareholders who hold equity stakes in publicly traded and privately held European banks for each year over the period 1999–2008. We show that about 62% of banks’ ultimate largest shareholders are diversified investors, holding on average equity investments from thirteen companies in their portfolio.We exploit this heterogeneity to investigate: 1) the impact of their portfolio diversification on bank risktaking; and 2) the implications of portfolio diversification on the efficiency of capital allocation. Our results show that the relation between portfolio diversification and bank risk-taking is both statistically significant and economically sizeable. We further show that portfolio diversification has a positive and significant effect on the efficiency of capital allocation. Overall, these findings contribute to the literature by studying for the first time a specific channel through which financial development, in the form of bank shareholders’ diversification, affects both the banks’ risk-taking decisions and the real economy.