The Correlation Between Income Diversification on the Efficiency of Microfinance Banks in Kenya

Abstract

Increasing the percentage of fees, net trading profits, and other non-interest revenue in a bank's net operating income is referred to as "income diversification" in the banking industry. According to finance theory, a bank's risk-adjusted performance should increase and its degree of risk should decrease as its income sources diversify. Most microfinance 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. This claim—that nearly 40% of these banks' net income comes from non-interest sources—is supported by an analysis of their financial statements. The study looked at how income diversity affected Kenyan publicly traded banks' operational effectiveness. The study sample comprised of 14 microfinance banks located in Kenya. The study's time frame was from 2018 to 2022. There was a descriptive design used in the investigation. The control variables included liquidity, capital sufficiency, and bank size. According to the study's results, the independent variables may account for about 20.1% of the efficiency variation, with irrelevant factors responsible for the remaining 79.9%. The R-square value for the study was found to be 0.201. It was established that the model was of statistical significance and, therefore, adequate for the investigation, with an ANOVA analysis p-value of 0.022. Efficiency and income diversity have a weak and statistically insignificant relationship, according to the Herfindahl-Hirschman Index (HHI). The effectiveness of a bank and its size were found to be positively and strongly correlated by the study. Efficiency and capital sufficiency revealed a negative connection that was not statistically significant. It was shown that liquidity has a small but favorable impact on efficiency. The study suggests that each bank should create a customized income diversification plan. Additionally, investors are encouraged not to worry about income diversification when selecting investment options because it does not imply improved efficiency.