  Against the widely held belief that diversification at banking institutions
contributes to the stability of the financial system, Wagner (2010) found that
diversification actually makes systemic crisis more likely. While it is true,
as Wagner asserts, that the probability of joint default of the diversified
portfolios is larger; we contend that, as common practice, the effect of
diversification is examined with respect to a risk measure like VaR. We find
that when banks use VaR, diversification does reduce individual and systemic
risk. This, in turn, generates a different set of incentives for banks and
regulators.
