Impact of income diversification on bank stability: a cross-country analysis

Abstract

PurposeThe impact of diversification on bank stability and risk remains an ongoing topic of discussion with inconclusive results. Hence, this study investigated the implications of income diversification on bank stability within African markets.Design/methodology/approachThe study utilised longitudinal financial data on 45 countries from 2000 to 2017 and employed static and dynamic panel model estimation.FindingsThe results of the study suggest income diversification technique could improve financial stability throughout typical and crisis periods which validate portfolio management theory. The study also confirms the “too big to fail” hypothesis, extensive diversifying over an optimal range negatively impacts stability. Banks with a high level of liquidity, a higher operating efficiency and a larger deposit ratio become more resilient. Banking capital regulations found to be the appropriate monitoring instrument for lowering risks and maintaining stability. However, profitability was found to have a positive effect on bank risk-taking. The finding also suggests that political institutions have substantial, direct implications that are positively related to bank fragility. Macroeconomic factors such as gross domestic product (GDP) growth and inflation also influenced bank stability.Practical implicationsThis study has important implications for bankers, regulators and academicians concerned about the effect of diversification on a bank’s risk-taking or stability in developing economies.Originality/valueTo the best of the author’s knowledge, this is the first study on Africa to analyse the quadratic influence of income diversification and the effects of political institutions on the level of bank stability.