The effect of diversification of the credit portfolio on bank's credit risk

The credit portfolio management and the optimal credit portfolio selection are identified as one of the most effective factors in banks’ credit risk. Two main strategies in this regard include diversification versus concentration. In this study, at first, the status of diversification of Iran’s banking sector is analyzed, then the relationship between diversification of the credit portfolio and credit risk is considered. It should be noted that in order to measure credit portfolio diversification two set of naive indexes and benchmark (distance) indexes is used. The empirical evidences have obtained through a panel data analysis in a sample of 16 Iranian banks during 2006 to 2011 time period. The findings indicate that increase in credit portfolio diversification lead to increment in bank’s credit risk and this relationship is independent of the type of bank ownership.