Abstract:
Licensed commercial banks are the backbone of Sri Lanka’s financial system, holding
more than 55% of the total assets in the sector and playing a vital role in ensuring
price and economic stability. During the economic crisis, income diversification has
emerged as a critical strategic tool for sustaining profitability and resilience. This
study investigates the impact of income diversification, measured using the
Herfindahl-Hirschman Index (HHI), on the financial performance of Sri Lankan
commercial banks over the period 2014 to 2024. The analysis placed special emphasis
on the shift towards fee-based income as a means of reducing reliance on traditional
interest income, thereby mitigating risks associated with interest rate volatility and
economic instability. Financial performance is measured using Return on Assets and
Return on Equity, with non-performing loans and firm size included as control
variables. A sample of 10 licensed commercial banks was selected using a random
sampling method. The study applied multiple regression analysis supported by
descriptive and correlation techniques. Findings reveal that income diversification
has a significant negative effect on Return on Assets while significant positive effect
on Return on Equity. Further, results showed non-performing loans significantly
impact Return on Assets while it does not impact on Return on Equity, highlighting
the sensitivity of asset returns to non-performing loans. The results underscore that,
in times of economic distress, revenue diversification particularly through the
expansion of fee-based services can strengthen banks’ financial resilience, stabilize
earnings, and reduce vulnerability to macroeconomic shocks. The study recommends
that bank management and policymakers encourage broader adoption of
diversification strategies to ensure long-term stability and performance in the Sri
Lankan banking sector.
