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Income Diversification and Risk-adjusted Returns for Indian Banks
Of late, banks are under pressure to improve their performance and asset quality. Diversifying income might improve their performance at a time when interest incomes are under strain. This article covers trends in diversification from 2000 to 2017 and explores the relationship between income diversification and risk-adjusted returns for banks in India. Our research supports the hypothesis that banks diversifying into non-interest income category are able to get higher risk-adjusted returns. For public sector banks, it is found that it is the dividend and treasury income that is contributing positively and significantly to risk-adjusted return.
The authors thank the anonymous referee for helpful comments that improved the content and exposition of the article.
The banking sector plays an important role in efficient intermediation between savings and loans. Indian banking is known for higher net interest margin (NIM), understood as the difference in interest rates between deposit and lending, relative to the amount of interest earning assets. In the recent past, with the likely continued pressure on the NIM, it is expected that Indian banks will make up for the shortfall in major sources of revenue from income diversification or non-interest income. The present technological changes and entry of fintech companies are likely to reduce low-cost deposits, further affecting interest margins. While some of the private sector banks have been able to generate higher income from both interest and non-interest income, public sector banks are required to put more efforts in generating income from non-interest sources.
The restriction imposed on lending activity through prompt corrective action for some banks will further reduce avenues of interest income. Along with coverage of aspects like recapitalisation, appointments, governance, bad loans, empowerment, and accountability, there is government expectation through Indradhanush reforms, launched on 24 August 2015, to improve public sector bank performance and also increase contribution of fee-based income by 200 basis points. There is considerable debate regarding higher NIM in Indian banking. When banks have a high NIM, it is expected for banks to become more efficient and competitive. In 2010, D Subbarao, the then governor of the Reserve Bank of India (RBI), said,
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