Income diversification and its effect on financial performance of listed banks in Kenya

Abstract

This study aims to investigate the effect of income diversification on bank performance during the period 2012-2018. Financial performance was evaluated based on bank profitability and solvency. A descriptive research design was used. Secondary data was collected from the Central Bank Website, the NSE and the respective websites of the banks. The fixed effect and random effects models for panel data were used to study the relationship. The Herfindahl-Hirshman Index was used as a measure for income diversification. Profitability was measured by ROA and ROE. Solvency was measured by capital adequacy and asset quality. The statistical significance of each independent variable was tested by performing at-test at 5% level of significance. The explanatory variable explanatory power was evaluated using the coefficient of determination, R2 . Based on the fixed effect modelS, income diversification has a negative impact on profitability measured by both ROA and ROE. The effect is significant for ROA but is insignificant on ROE. As for solvency, random effect models reveal that income diversification has a positive effect on bank solvency as measures by capital adequacy and asset quality. The effect is significant for capital adequacy but is insignificant for asset quality. The study concluded that income diversification has a negative effect on probability and a positive effect on solvency. It is therefore recommended for banks to commit their resources to expand their noninterest income revenue streams if they want to improve their solvency levels. However, it should be done with caution as it may be at the expense of profitability.