THE IMPACT OF PORTFOLIO DIVERSIFICATION ON THE PROFITABILITY OF LICENSED COMMERCIAL BANKS IN SRI LANKA
.Menike, M.G.P.D
University of Peradeniya, Sri Lanka
menike@mgt.pdn.ac.lk
ABSTRACT
DOI : 10.57075/jaf1112407
Licensed commercial banks are essential for ensuring the stability of any country’s financial system. According to the 2022 annual report of the Central Bank of Sri Lanka (CBSL), licensed commercial banks collectively held fifty-five percent of total assets. Portfolio diversification stands as a fundamental strategy for mitigating risk and enhancing returns in the banking sector. Thus, this study aims to investigate the relationship between portfolio diversification and profitability within the realm of licensed commercial banks operating in Sri Lanka. The researcher set out to achieve two research objectives by examining the correlation between the diversification index and profitability. Return on Asset and Return on Equity were used as measurement criterion of profitability. The dependent variable, portfolio diversification, was measured using a diversification index derived from the Herfindahl-Hirschman Index (HHI). A sample of ten listed banks was selected out of twenty-four licensed commercial banks. Secondary data were collected from the annual reports of ten listed commercial banks for the period of 2012 – 2022. A fixed effect model was selected among panel data regression models after conducting the F test, LM test, and Hausman test. The study’s findings indicate that the diversification index has an insignificant negative impact on ROA and a significant negative impact on ROE. The equity ratio of banks has a negative, insignificant impact on both ROA and ROE. Bank size has a significant and negative impact on both ROA and ROE. Therefore, the findings of the study demonstrate that diversification negatively impacts both ROA and ROE. The findings from this study hold significant implications for both banking institutions and policymakers in Sri Lanka. Understanding the relationship between portfolio diversification and profitability can inform strategic decision-making within banks, guiding them towards more effective risk management practices and resource allocation strategies. In essence, this study contributes to the existing literature by offering empirical evidence and theoretical insights into the impact of portfolio diversification on the profitability of licensed commercial banks in Sri Lanka.
Keywords : Asset -based diversification, Commercial banks, Diversification index Portfolio diversification, Profitability.
