The Effect of Asset Diversification on Profitability of Commercial Banks in Ethiopia

Abstract

Background: Asset diversification is a crucial strategy for commercial banks to manage risk and enhance profitability. This study investigates the impact of asset diversification on the financial performance of Ethiopian commercial banks.

Methods: A panel regression analysis was conducted using secondary data from eight commercial banks in Ethiopia over the period 2011-2020 (80 observations). The study examined the relationship between asset diversification (measured by loans and advances, financial assets, cash and cash equivalents, and fixed assets) and profitability (return on assets).

Results: The regression model was statistically significant (p-value < 0.000), indicating that asset diversification has a measurable impact on profitability. Specifically, the study found that: Loans and advances had a positive and statistically significant effect on profitability. Conversely, financial assets exhibited a negative and statistically significant effect. Likewise, Cash and cash equivalents had a negative and statistically significant effect. However, fixed assets did not show a statistically significant relationship with profitability.

Conclusion: The findings suggest that Ethiopian commercial banks should strategically diversify their asset portfolios towards loans and advances while being mindful of excessive holdings in financial assets and cash. This approach can potentially improve profitability and contribute to sustainable financial performance.