Income Diversification and Bank Risk-Return Trade-Off on the Nepalese Commercial Banks

Abstract

This study examines an impact of income diversification on the risk return trade off in the Nepalese commercial banks. Risk adjusted performance variables in terms of risk adjusted return on assets and risk adjusted return on equity are the dependent variables of the study. The study employs the secondary data gathered for twenty Nepalese commercial banks from 2009 to 2015. The secondary panel data are collected from Banking and Financial Statistics and annual reports of the selected commercial banks. The regression models are estimated to test the significance and importance of income diversification variables on the risk adjusted performance of Nepalese commercial banks. The results show that non-interest income, foreign ownership and bank size are positively correlated to risk adjusted returns. It indicates that higher the non-interest income, foreign ownership and bigger the bank size, higher would be the risk adjusted returns. However, the study also reveals that equity to total assets ratio and loan to total assets ratio have negative relationship with the risk adjusted return on assets and risk adjusted return on equity. The regression results conclude that the beta coefficients are positive for non-interest income, Herfindahl-Hirschman Index–HHI, and foreign ownership which indicate the positive impact on risk adjusted performance. The results further reveal that equity to total assets ratio and loan to total assets ratio have negative effect on the risk adjusted performance of Nepalese commercial banks. The study concludes that income diversification-HHI followed noninterest income, equity to total assets ratio and foreign ownership are the most dominant factors that affect the risk return trade off in the context of Nepalese commercial banks.