Does Size Matter? Portfolio Diversification and Financial Performance of Commercial Banks in Kenya: Testing the Moderating Effect of Bank Size

Main Article Content

Abigael Okwaro
Stephen Chelogoi https://orcid.org/0000-0003-2146-7745
Collins Kapkiyai https://orcid.org/0000-0002-7171-6212

Keywords

Financial Performance, investment portfolio, , diversification, commercial banks, bank size

Abstract

Commercial banks contribute significantly to the development of a nation. An increasingly robust and dynamic finance system is essential for economic expansion. Diversification is crucial to commercial bank risk management and consequently, financial performance. Diversification reduces the probability of a commercial bank failing by mitigating systemic risk. Due to increased expenses and exhausted economies of scale, diversification may not always result in higher financial performance. The purpose of this study was to investigate the moderating effect of bank size on the relationship between investment portfolio diversification and financial performance of banks in Kenya. Modern portfolio theory, organizational lifecycle theory and growth of firm theory provided the theoretical foundation for the study. To investigate this link, this research employed a longitudinal and explanatory design approach targeting 42 registered banks in Kenya. From the annual financial statements of the institutions and the annual reports of the Central Bank of Kenya, 210-year observations of secondary data were extracted for the study spanning 2007-2021. The study's data were analysed using descriptive and inferential statistics, as well as statistical techniques such as the Pearson correlation coefficient and regression analysis. The hypotheses were evaluated using a hierarchical multiple regression model at a significance level of 0.05. Pearson correlation analysis results revealed that a statistically significant negative correlation between deposit portfolio diversification (DPD) and return on assets (ROA) (r = -0.348, p < 0.05). The study findings revealed that diversification of investment portfolios had a positive and statistically significant impact on the financial performance of commercial banks (β = .153, p < 0.05). Further, bank size had a positive and significant effect on financial performance (β = 0.414, p < 0.05). The study established that bank size does not moderate the relationship between investments portfolio diversification and financial performance of commercial banks (ΔR2=0.716, β= -0.002, p> 0.05). The study has managerial and practical implications for commercial banks to ensure they diversify their portfolio and avoid over-reliance on the domestic sector. Specifically, commercial banks are advised to diversify their investment portfolios to ensure their financial stability and to take advantage of low-risk government securities. Policymakers and regulators in Kenya's commercial banking sector, should formulate policies and regulations that encourage mergers, acquisitions, and portfolio diversification

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