Indian banking sector has undergone sea changes over the years. Much of these changes are the consequences of irreversible process of liberalization, globalization and privatization. Banks in India, to a large extent, have become functionally dynamic and operationally efficient. One of the important developments one can witness in the sector is the growing scale of geographical and revenue diversification over the years. Geographical diversification is expected to bring positive results by way of reduced risks and increased returns for the Indian banks. Against the backdrop of existing literature which renders diverse views about the diversification benefits, the present study examines the manner and the extent to which banks are geographically diversified in the case of both public and private sector banks and analyzes its impact on the performance measured in terms of returns. The study uses a panel dataset of 40 observations for the period 1994-2014. In order to examine the impact of geographical diversification on bank’s risk and returns, a Least Square Dummy Variable (LSDV) regression model is used. The results indicate that public sector banks are more diversified than private sector banks and the geographical diversification has a negative impact on the returns of the banks.

The Indian banking sector has undergone rapid transformations following the waves of reforms mainly post the 1990s. The overall orientation of the banks has changed enormously due to technological upgradation, competition and liberalization. As a consequent factor, like many countries of the world, there has been an increased trend towards income and geographical diversification. This increased reliance on non-traditional or non-interest making activities, along with the geographical expansion of banks all over the country, is expected to yield the potential diversification benefits in the sense that it can stabilize the earnings of a bank by reducing the cyclical variations of bank’s earnings and create resilience to counter adverse shocks affecting revenue and profits. In other words, the standard theory on geographical diversification is laid on the fundamental argument that banks should concentrate only on those areas/regions in which they have inceptions by creating awareness among the customers of that particular regions about their products and services. But at present all the categories of banks are making efforts to spread their products and services to all parts of the country by setting up their branches in different regions, and by doing so they are in a position to call themselves a national player rather than a regional player. The Reserve Bank of India (RBI) has laid down some guidelines regarding the opening up of a new bank branch in rural, urban, semi-urban and metropolitan regions of the country. The opening of new branches and shifting of existing branches of banks is governed by the provisions of Section 23 of the Banking Regulation Act, 1949. In terms of these provisions, banks cannot, without the prior approval of the RBI, set up any branch. Domestic scheduled commercial banks (other than regional rural banks) are presently permitted to open branches without prior approval from RBI. For the purpose of ensuring more uniform spatial distribution, banks are encouraged to open branches in under banked centers, more precisely, in underbanked districts of underbanked states.