INCOME DIVERSIFICATION AND PROFITABILITY OF BANKS: EVIDENCE FROM GHANA’S BANKING SECTOR

Abstract

Non-interest income accounts forasignificantpercentageof operatingincomeof commercial banking industry. However, current studies on income diversification and profitability of banks have centered on the implications of diversification without investigatingthe threshold effects and transmission channels through which income diversification affects banks profitability. The study addresses these gaps in the literature relying on panel data from 10 banksinGhanaspanning2006–2016. Weemployboththefixedandrandomeffectestimation approach. The study finds that, while increased diversification proxied by non–interest income is associated with higher profitability of banks in Ghana, the effect is not robust. Further results suggest that, the effect of income diversification on profitability is monotonic and do not show evidence of threshold effects. On the channels of manifestation, the study observes that, income diversification increases profitability and non-performing loans heighten the positive relationship between non-interest income and profitability. In the light of the banks diversifying their source of income, we recommend that banks increase their income diversification drive in order to maximize performance.