Does Income Diversification Affect Bank Efficiency, Effectiveness and Performance? Evidence from Indian Banking Industry

Banks are currently facing significant pressure to enhance their performance and bolster their financial stability. The strategy of diversifying income has emerged as a powerful tool to aid banks in improving their performance, particularly when their interest income is strained. The present study delves into the impact of income diversification on the efficiency, effectiveness, and overall performance of Indian banks. In this study, we conceptualize bank performance as an outcome of two distinct yet interconnected components: efficiency and effectiveness. To measure these facets of bank performance, we construct a two-stage performance evaluation model that accounts for undesirable outputs. To quantify bank performance and its components, we model a two-stage performance evaluation model with undesirable outputs and applied an extended version of Tone and Tsutsui (2009) network SBM model. To investigate the linear and non-linear impact of income diversification on efficiency, effectiveness, and performance, we employ panel LASSO technique. The findings highlight the presence of performance disparities among Indian banks, categorized by ownership groups. Remarkably, private banks outperform their counterparts in the public sector across all dimensions of performance. Interestingly, our study reveals a negative and significant influence of income diversification on bank efficiency, effectiveness, and overall performance.