Abstract:
Credit risk attached with commercial bank loans can be considered as one of the main risks which commercial banks face. Thus, commercial banks diversify their loan portfolio to enhance performance through mitigating the credit risk. Loan portfolio diversification refers to providing loans into different sectors without concentrating on a particular sector. However, there is no consensus in the literature about the link between loan portfolio diversification and performance of commercial banks. Therefore this study examines the impact of loan portfolio diversification on performance of commercial banks in Sri Lanka. Hirschman Herfindahl Index was used to measure the loan portfolio diversification while performance measured by the CAMEL model. The variables such as Interest Rate Spread and Bank size are considered as the control variables. Data were collected from audited annual financial statements of commercial banks during the period of 2008 – 2017. The sample consists of ten licensed commercial banks including six systemically important commercial banks in Sri Lanka out of 25 licensed commercial banks in Sri Lanka. Data were analyzed by using Pearson correlation and fixed effect panel regression model. The results reveal that there is a significant negative impact of loan portfolio diversification on commercial bank performance. Further, control variables-bank size positively links with commercial bank performance while interest rate spread has positive insignificant impact on bank performance. In conclusion, it is confirmed that commercial banks should reduce their loan portfolio diversification as much as possible to increase the performance. Because results revealed that diversified loan portfolio position leads poor performance of commercial banks. The management should follow specific strategies about LPD and improve commercial bank performance while making high attention about loan portfolio position of the bank.
Description:
Keywords: Credit Risk, Loan Portfolio Diversification, Loan Portfolio Concentration, Hirschman Herfindahl Index, Interest Rate Spread
