Asset Diversification and Financial Stability of Commercial Banks in Kenya: The Mediating Role of Financial Performance

Abstract

The core function of commercial banks is financial intermediation, with the aim to generate profits, acting  as intermediaries between savers and borrowers. Today’s credit markets are however faced with increased competition, forcing them to seek other alternative revenue earning sources. Therefore, they are diversifying their assets to seek profits, mitigate risks and enhance their financial stability. This study examined the influence of asset diversification on financial stability of commercial banks in Kenya, and whether financial performance influences the relationship. An Ex post facto correlational research design was employed, covering 38 commercial banks registered during the period 2014-2023 with no sampling.  Secondary data was collected using a document analysis guide and for measurement of variables, ratio scale was used. Asset diversification was measured using the, Z-score measured financial stability while ROA was used to measure financial performance. Regression analysis and F-test were used for testing the hypothesis. The study found a positive significant effect of asset diversification on financial stability (β = 0.837, p-value = 0.0008).Regarding mediation, it was found that financial performance had a significant effect on financial stability (β=0.047, p- alue <0.01) and the relationship between asset diversification and financial stability remained significant (β=0.032, p-value <0.05), an indication that financial performance had a significant mediation on the relationship. It was concluded that financial performance has a mediating effect on the relationship between asset diversification and financial stability of commercial banks in Kenya and recommended that the banks should consider asset diversification strategies to mitigate unsystematic risk and maintain their financial stability.