Income and balance sheet diversification effects on banks' cost and profit efficiency: Evidence from the United States

Using two-step system generalized method of moments approach, we provide empirical evidence on the impact of income, asset, and funding diversification on the cost and profit efficiency of US commercial banks from 2002 to 2019. Furthermore, we use two-stage least squares to examine the interdependence between cost efficiency and profit efficiency. Our results show that funding and income (assets) diversification has a positive (detrimental) effect on the cost efficiency of banks, whereas funding (income and assets) diversification has a significantly negative (positive) effect on profit efficiency. Our findings reveal that during the global financial crisis, asset diversification is not beneficial for banks, whereas funding ‎diversification has a positive effect on cost and profit efficiency.‎ Our results confirm bidirectional causality between cost and profit efficiency in US commercial banks. Our mixed results on the influence of income, asset, and funding diversification on the cost and profit efficiency of banks with varying characteristics have useful implications for policymakers and regulators‎.