Effect of Income Diversification on Financial Performance with Moderating Role of Financial Stability: Evidence from Commercial Banks in Afghanistan Using the CAMEL-DEA Approach

Abstract

This study aims to analyze the impact of income diversification on the financial performance with the moderating role of financial stability of commercial banks (CBs) in Afghanistan. Currently, there is no empirical evidence related to this topic in Afghanistan. This study analyzes data from eight CBs covering the period from 2015 to 2024. The data were collected from the official websites of the respective banks. For the analysis, the author has employed panel data regression analysis techniques, including the Fixed Effects Model (FEM), Random Effects Model (REM), and Pooled Ordinary Least Squares (OLS) model. For the measurement of financial performance, the study used the capital adequacy, assets quality, management quality, earnings, and liquidity (CAMEL) framework, and for the measurement of income diversification, the study used the Herfindahl-Hirschman Index (HHI). For measuring FS, the author used the Z-score. The study concludes and confirms that income diversification significantly improves the financial performance of Afghan CBs and have a significant relationship. Furthermore, financial stability as a moderating variable improves the impact of income diversification on financial performance, and found to be positive and significant. The findings back up portfolio theory and say that for the purpose of improving financial performance and maintaining risk the most important factor to consider is income diversification. This study is significant for a number of reasons. For one, the examination of income diversification in conjunction with stability as a moderating variable is the first study of its kind in Afghanistan. This study results are of the practical value to customers in improving their trust, investors for their investment in non interest based activities, bank managers for focusing more on managing the non interest activities, policymakers for making relevant policies to support non interest based activities, and other stakeholders for believing on banks in Afghanistan.