Effects of Income Diversification On Financial Performance of Commercial Banks Listed at Nairobi Security Exchange

Abstract

The aim of this study was to determine the effect of income diversification on financial performance of commercial banks listed at the Nairobi Securities Exchange. A descriptive research design was adopted. A census targeting the listed commercial banks at NSE from year 2012 to 2016 was conducted. Secondary data was collected from NSE, CBK’s annual supervision report and the respective websites of the banks. Regression model was adopted to determine the effect of income diversification on financial performance. Herfindahl-Hirshman index was used to measure income diversification and three control variables were included, namely; size, capital adequacy and liquidity. The statistical significance of each independent variable was tested by performing a t-test at 5% level of significance. Significance of regression model was tested by performing an F-test at 5% significance level. The independent variables explanatory power was evaluated using the coefficient of determination, R2. The study found that, income diversification was negatively related to financial performance. Results of t-test indicated that, the effect was not statistically significant. It also found that, size and capital adequacy had a positive effect which were statistically significant while liquidity had a negative impact on financial performance and was not statistically significant. The coefficient of determination for the regression was found to be 25.9%. This implied that, the independent variable explained only 25.9% of the changes in the dependent variable. The study concluded that, income diversification is a costly affair for commercial banks since it has a negative impact on financial performance. It also concluded that, size and capital adequacy had a positive impact on financial performance while liquidity had a negative impact. The limitation of this study which was brought by the cost and time constraint in this study is that it was carried on the listed commercial banks at the NSE. The data results may not be applicable to other financial firms as the focus in this study was on banks and this is because of the differences that are found between commercial banks and other financial firms. This study recommends that, commercial banks should not commit resources in diversifying their income because diversification appears to be a costly affair. Also investors should not be concerned about a banks’ income diversification in selecting investment opportunities as diversification of income does not generate positive financial performance. Further, studies may consider the effects of diversification of income on performance of Islamic banks or the impact of geographical diversification on performance of commercial banks.