Sectoral Diversification and Bank Performance : An Empirical Study on Domestic Licensed Commercial Banks in Sri Lanka

While the traditional banking theory and portfolio theory favour diversification strategy for better performance the corporate finance theory supports concentration strategy. The empirical studies also provide mixed evidence on the relationship between sectoral loan diversification and the banks' performance. This paper empirically investigates the relationship between the sectoral diversification and the performance of Sri Lankan domestic licensed commercial banks over the period of 2008 to 2014 using Panel Least Squares, Random Effect Model and Dynamic Panel Model. The key finding of this study is that the sectoral loan diversification, on average, leads to poor performance in domestic LCBs in Sri Lanka when conditioned to log of total assets, personnel cost ratio, equity ratio, credit risk and ownership. In addition it also reveals that the less risky banks generated more return when they followed concentration strategy and the state ownership has further weakened the profitability of diversification