Could Regional and Cantonal Banks Reduce Credit Risk through National Diversification?

Abstract

This paper estimates the reduction of credit risk that can be achieved in Switzerland through a national diversification of bank lending. Using a credit risk model based on corporate default rates, we find that the risk of a nationally diversified loan portfolio can be up to 20% smaller than the average of the risks of cantonal portfolios. From a financial stability perspective, this substantial risk diversification potential should motivate particular scrutiny on the more than hundred Swiss banks staying on the regional business model.