Is Loan Diversification Always Beneficial? Nonlinear Evidence from Vietnamese Commercial Banks

Abstract

This study investigates the nonlinear relationship between sectoral loan diversification and credit risk in Vietnamese commercial banks. Using a balanced panel of 14 banks over 2012–2025, comprising 196 bank-year observations, the study measures diversification through a Shannon Entropy Index based on a harmonized ten-sector classification and measures credit risk using the reported non-performing loan ratio. The relationship is examined using conventional panel estimators, two-step System GMM, and bias-corrected LSDV models, together with alternative diversification measures. The results provide suggestive evidence of a U-shaped association: diversification is associated with lower credit risk at relatively low levels but with higher credit risk beyond a conditional turning point. This pattern is supported by the System GMM and small-sample bias-corrected estimates, although it is not statistically robust to the HHI-based measure. The findings therefore indicate that the effects of diversification depend on both its extent and measurement and should not be interpreted as identifying a universal optimal threshold. Banks and supervisors should assess sectoral diversification alongside cross-sector risk correlations, underwriting expertise, and monitoring capacity.