Bank Diversification and Financial Constraints on Firm Investment Decisions in a Bank-Based Financial System

Abstract

The purpose of the study is to investigate whether bank diversification influences borrowing firms’ financial constraints on investment decisions. It also analyzes whether the different dimensions of bank diversification could alleviate financial constraints to firm investment. Further, the role of bank diversification in achieving firm financial sustainability is explored. By applying the Two-step System GMM, this study examines the effect of changes in bank diversification on financial constraints to borrowing firm investment in a reduced-form investment model with a sample of 810 listed firms in Taiwan over the period 1997–2019. The empirical findings indicate that firms are financially constrained as well as there being a positive relationship between cash flow and investment among Taiwanese listed firms. Additionally, bank diversification significantly reduces the investment-cash flow sensitivity of firms, suggesting that bank diversification mitigates the financial constraints to borrowing firms. Moreover, the multi-diversification of a bank compared to single-diversification will have greater impact on mitigating the firms’ financial constraints on investment. Thus, bank diversification strategies are proposed in a bank-based financial system, leading to the easing of the borrowing firms’ financial constraints to investments.