The Effect of Income Diversification on the Efficiency of Commercial Banks Listed at the Nairobi Security Exchange

Abstract

Due to policies associated with financial liberalization, financial institutions have been able to register increased income from their non-traditional income sources as witnessed in majority of the banks increasing or engaging in non-intermediation activities. Most commercial banks are known to generate majority of their income from interest sources, however there has been a gradual shift in recent years, as they are now diversifying by venturing into non-interest sources of income generation. Analysis of the financial statements of these banks confirms this assertion where almost 40% of their net income can be traced from their non-interest sources. This study sought to establish the effect of income diversification on the efficiency of commercial banks listed at the Nairobi Securities Exchange. A census targeting the listed commercial banks at the NSE from 2012 to 2016 was conducted. CBK annual supervision reports NSE reports and the respective websites of the banks provided the secondary information used in the study. A descriptive research design and multiple regression model was adopted in the analysis. Herfindahl-Hirshman index was used to measure income diversification and three control variables were included, namely; size, capital adequacy and liquidity. The study found that, income diversification and efficiency of commercial banks were negatively related. Results of t-test indicated that, the effect was not statistically significant. Liquidity had a positive and insignificant effect on the efficiency. Bank size had a positive effect on efficiency. The relationship was however, statistically significant. The results further revealed that capital adequacy ratio was had a negative and insignificant effect on the efficiency of commercial banks listed in Kenya. The study highlighted the need to develop income diversification strategies specifically tailored for each commercial bank with a focus on income diversification. Also investors should not be concerned about a banks‘ income diversification in selecting investment opportunities as diversification of income does not result into increased efficiency. Further studies may consider income diversification strategies and their impact on Islamic banks efficiency to see whether a greater reliance on non-financing income impacts on efficiency and, if so, how this may vary between Islamic and conventional banks.