The general objective of this study is to investigate the impact of income source diversification on financial performance of commercial banks in Ethiopia. Commercial banks in Ethiopia are currently facing competition from non-bank institutions entry into the activities which was in the past only role of banks. Therefore, banks started searching new income sources rather than focusing only traditional inter-mediation income generating activities. Thus, this study was to examine the impact of income sources diversification on bank performance in case of some selected commercial banks in Ethiopia by using panel data over the period 2010-2015. The study used secondary data collected mainly from each sampled banks annual report financial statements. Since the data is secondary in nature, quantitative approach was adopted. This data was analyzed by using STATA version 12 and Microsoft Excel. Fixed effect model was used, since this model is preferred than the random effect model based on the hausman specification test. Return on asset (ROA) was used as dependent variable while income diversification (Div) as independent variable with control variables such as bank size (BS) in terms of total assets, equity/ assets ratio (EAR), loan/asset ratio (LAR) and expense/income ratio (Exp). The findings of the study show that the level of diversification has a positive impact on financial performance of Ethiopian commercial banks. In addition, the study also revealed that EAR, LAR and BS had positive impact on financial performance while Exp had negative impact. The results of the study are important for bankers to understand how income diversification affects the performance of banks. Therefore, the study recommended that banks should diversify their sources of income into interest and non-interest as well as reduce operating expense in effective way, so as to enhance their performance (ROA).
Table of Contents
CHAPTER ONE
INTRODUCTION
1.1 Background of the study
1.2 Statement of the problem
1.3 Objectives of the study
1.3.1 General objective
1.3.2 Specific objectives
1.4 Significance of the study
1.5 Scope and limitation of the study
1.6 Structure of the thesis
CHAPTER TWO
RELATED LITERATURE REVIEW
2.1 Theoretical Review
2.1.1 Definitions of diversification
2.1.2 Why Diversification?
2.1.3 Approaches to Bank Diversification
2.1.4 Financial Performance Measures
2.1.5 The Role of banks
2.1.6 History of Ethiopian banking sectors
2.1.7 Development in Ethiopian banking sector
2.2 Empirical Literature
CHAPTER THREE
RESEARCH DESIGN AND METHODOLOGY
3.1 Research Design
3.2 Sources of Data and Method of Data Collection
3.3 Target Population, Sample size and Sampling Technique
3.4 Econometric Approach
3.5 Methods Data Analysis
CHAPTER FOUR
EMPIRICAL RESULTS AND DISCUSSION
4.1 Descriptive Statistics and Trend Analysis
4.1.1 Trend analysis
4.1.2 Descriptive statistics
4.2 Correlation Analysis
4.3 Regression Analysis
4.3.1 Testing assumptions of classical linear regression model (CLRM)
4.3.2 Random versus fixed effect model
4.4 Multiple Regression Analysis
4.5 Interpretation of the Finding
CHAPTER FIVE
CONCLUSIONS AND RECOMMENDATIONS
5.1 Conclusions
5.2 Recommendations
5.3 Future Research Direction
Research Objectives and Focus
This thesis examines the impact of income source diversification on the financial performance of selected commercial banks in Ethiopia. The core research question addresses how diversifying revenue streams beyond traditional interest-bearing activities influences the Return on Assets (ROA) of these banking institutions.
- Analysis of the relationship between income diversification and bank profitability.
- Evaluation of the influence of non-interest income on total operating income stability.
- Utilization of panel data econometric models to assess performance metrics.
- Identification of critical control variables including bank size, equity/asset ratios, and expense management.
Excerpt from the Book
1.1 Background of the study
The portfolio theory of the Markowitz (1952) points out that diversification can decrease risk when individual assets are not fully correlated. Theory of bank diversification suggests the existence of several types of diversification which include; income diversification, assets diversification, credit diversification, geographical diversification and international diversification. Banks can diversify by investing in financial securities, participating in Fed funds and other securities in addition to making loans. Commercial banks can diversify not only their lending portfolio but also their investments. Income source diversification of bank is an expansion of new income earning financial services other than the traditional intermediation services. It involves the shift of reliance from the interest income sources associated with traditional intermediation activities to innovative non-interest income earning activities (Kiewu, 2012). Income diversification can be measured using the Herfindahl Hirschman Index and the Entropy Index which accounts for the variations in the breakdown of net operating income into interest income and non-interest income (Stiroh and Rumble, 2006).
The financial industry in developed as well as in developing countries has experienced major changes (Crouzille, et al, 2013). Deregulation and increased competition has led banks to expand their activities and to develop new lines of businesses beside their traditional interest activities (Edwards & Mishkin, 1995). Banks have diversified their income sources by performing new activities, such as underwriting and trading securities, brokerage and investment banking and other activities, which generate non-interest income (Crouzille, et al, 2013). Banks are transcending their normal business operations and diversifying their activities in response to economic and financial sector reforms. In recent years, deregulation and technological innovation has permitted almost all financial institutions to capture an increasing share of their income stream from noninterest sources. According to DeYoung and Rice (2003), in US commercial banks an amount of non-interest income increase due to diversification into lines of business such as investment banking, venture capital and insurance underwriting, growth in fee-paying and commission-paying services linked to traditional retail banking services has also been significant.
Summary of Chapters
CHAPTER ONE: Provides the foundation for the study by defining the research problem, setting specific objectives, and outlining the scope of the thesis regarding Ethiopian commercial banks.
CHAPTER TWO: Reviews relevant theoretical frameworks and empirical literature concerning bank diversification, performance metrics, and the historical development of the Ethiopian banking sector.
CHAPTER THREE: Describes the methodology, including the quantitative research design, data collection sources from annual financial statements, and the panel data econometric approach used.
CHAPTER FOUR: Presents the empirical findings, covering trend analysis, descriptive statistics, and the results of the multiple regression analysis regarding the determinants of bank profitability.
CHAPTER FIVE: Concludes the study by summarizing the impact of diversification on performance and offering recommendations for commercial banks to enhance their operational efficiency and income mix.
Keywords
Income diversification, Bank performance, ROA, Commercial banks, Fixed effect, Non-interest income, Net interest income, Financial intermediation, Ethiopia, Panel data, Regression analysis, Operational efficiency.
Frequently Asked Questions
What is the primary focus of this research?
The research investigates how the diversification of income sources affects the financial performance of selected commercial banks operating in Ethiopia.
What are the central themes of the study?
The core themes include income source diversification, financial performance measurement (ROA), the role of non-interest income, and the regulatory environment of the Ethiopian banking sector.
What is the main objective of the thesis?
The study aims to determine if shifting from traditional interest-based activities to non-interest generating services improves the profitability and risk-adjusted performance of banks.
Which methodology is used to conduct the study?
The study adopts a quantitative approach, utilizing panel data regression models—specifically the fixed-effect model—analyzed via STATA version 12 and Microsoft Excel.
What does the main body of the work cover?
The main sections cover theoretical reviews of diversification, empirical literature, research design, statistical data analysis, and an interpretation of findings regarding the influence of control variables like bank size and expense management.
Which keywords characterize this work?
Key terms include Income diversification, Bank performance, ROA, Commercial banks, Fixed effect, and Financial intermediation.
Why was the fixed effect model preferred for this analysis?
Based on the Hausman specification test conducted within the study, the fixed effect model was deemed statistically more appropriate than the random effect model for evaluating the selected bank panel data.
What role does the 'expense to income ratio' play in the findings?
The study found a strong negative and statistically significant impact of operational efficiency (measured by expense ratio) on profitability, suggesting that banks must focus more on managing operational costs.
- Quote paper
- Mudesir Kasim (Author), 2016, The Impact of Income Sources Diversification on Bank Performance, Munich, GRIN Verlag, https://www.grin.com/document/535024
