Income diversification and bank efficiency in an emerging market

Abstract

Purpose – The purpose of this paper is to explore the non-linear relationship between income diversification and efficiency of Ghanaian banks within the universal banking era. Design/methodology/approach – The stochastic frontier analysis (SFA) technique is employed on annual data of 26 Ghanaian banks from 2003 to 2011 to estimate cost and profit efficiency scores. In the second stage analysis, a tobit regression model is estimated to examine the empirical effect of diversification into non-interest generating activities on estimated cost and profit efficiency scores while controlling for other bank specific characteristics. Findings – The findings of the SFA reveal high levels of efficiency in cost compared with profit to reflect high inefficiencies on the revenue side. An analysis of efficiency scores by two categories of bank size suggests that large banks have high cost and profit efficiency compared to small banks. A non-linear relationship is found between income diversification and efficiency while size was also found to be important in enabling banks exploit the potential benefits of income diversification. Research limitations/implications – This study focuses on one banking market in Africa. A comparative analysis in a cross-section of banking markets in Africa will be useful to bring robustness to the findings of this study. Practical implications – The findings of this study provides useful insights for management on the best corporate model in ensuring that diversification activities are efficiency-enhancing. Originality/value – This study presents the first empirical evidence on the non-linear relationship between efficiency and income diversification in emerging banking markets in Africa.