Income Diversification, Credit Risk and Profitability of Ethiopian Commercial Banks

Abstract

This study examined the impact of income diversification on credit risk-taking and profitability of commercial banks in Ethiopia. Additionally, it investigated how bank-specific and macroeconomic factors influence diversification, risk-taking and profitability of these banks. The analysis was based on unbalanced panel data of 19 banks over the period of 1997-2022. The empirical estimation relies on a two-step Generalized Methods of Moments (GMM) technique. The results indicate that commercial banks in Ethiopia tend to enhance their profitability by assuming greater credit risk. The findings also indicate that diversifying income sources toward non-traditional banking activities has a significant risk reducing and profit enhancing effect for Ethiopian commercial banks. This study further suggests that bank specific characteristics, such as bank size, capitalization and liquidity; macroeconomic conditions, and the structure of the banking industry play important role in determining income diversification, credit risk-taking and profitability of banks in Ethiopia. Finally, the paper concluded by recommending the importance of promoting diversification into non-traditional businesses so as to ensure more profitable and more stable commercial banking system in Ethiopia.