Question

“Because diversification is a desirable strategy for avoiding risk, it never makes sense for a bank to specialize in making specific types of loans.” Is this statement true, false, or uncertain? Explain your answer

Short answer

The given statement is misleading because when a bank specializes in making particular sorts of loans, it can show economies of scale and perform all the more proficiently. Specialization permits the bank to collect data regarding regional firms and find their creditworthiness more comfortable. This decreases the negative choice situation in which banks do not understand which firms have more adequate credit than the rest and decreases the chance of default.

Step-by-step solution

Concept Introduction

Diversification is the stratgey adopted to lower the risk in investment. Under this strategy, all the capital is not invested on one thing rather it is spread over a variety of high-risk and low-risk assets.

Explanation

The given statement is misleading because when a bank specializes in making particular sorts of loans, it can show economies of scale and perform all the more proficiently. Specialization permits the bank to collect data regarding regional firms and find their creditworthiness more comfortable. This decreases the negative choice situation in which banks do not understand which firms have more adequate credit than the rest and decreases the chance of default. In addition, when the bank expands loans, it collects interest periodically and these charges are backed by agreements and collaterals. Therefore, reimbursement on its loans is not that unsafe.