Diversification and performance of Sri Lankan banks

The purpose of this study is to investigate the relationship between diversification and the performance of commercial banks, while taking into account the ownership status of these banks in Sri Lanka. Two-way relationship between diversification and performance was scrutinised by employing the 2SLS regression technique. The data consists of 17 registered commercial bank in Sri Lanka between 2001-2016. The results show a strong significant bidirectional relationship exists between diversification and bank performance. The performance of Sri Lankan banks has been significantly improved by their diversification attempts. In other words, the banks whose incomes are more diversified from various sources, they are more profitable and successful in long-term. On the other hands, the results also reveal that bank performance positively and significantly affects diversification. This finding suggests that the banks with great profitability are more capable in diversify their operations. Furthermore, private sector banks, both listed and unlisted, are significantly more diversified than their government-owned counterparts, but their performance is not necessarily superior to government-owned banks. This may be the result of the economic environment and the perception of the public, which have allowed the government-owned banks to entertain significant market power over the private sector banks in the country.