Income diversification and bank risk-taking: The moderating role of intellectual capital

Abstract

The purpose of this study was to investigate whether intellectual capital (IC) moderates the relationship between income diversification and bank risk-taking. Quantitative data were collected from 50 East African banking firms between 2010 and 2021, yielding 600 bank-year observations. Bank risk-taking is measured using Z-SCORE and non-performing loans (NPLs). The value added intellectual capital (VAIC) and its coefficients: human capital efficiency (HCE), structural capital efficiency (SCE), and capital employed efficiency are used as proxy measures of IC. The system-generalized moment (GMM) was employed as the estimation model. According to the findings, banks with a higher non-interest income share take on excessive risk. Similarly, the findings show that VAIC, HCE, and CEE have a positive and statistically significant relationship with risk-taking. SCE, on the other hand, significantly reduces risk-taking. The findings also show that VAIC and its coefficients (HCE, SCE, and CEE) moderate the relationship between income diversification and risk-taking. These findings have implications for management and policy-makers. First, bank managers can use these findings to make strategic decisions about diversifying their income streams, mitigating associated risks, and determining how to best leverage IC to maximize profits. Second, regulators should increase oversight of non-lending activities by banks and, if necessary, impose regulatory ceilings. Furthermore, mandatory IC disclosure is required to uncover hidden bank value, which may inform risk management decisions among stakeholders. This is one of the first studies to provide empirical evidence of the relationship between income diversification and risk-taking in the East African region. Previous research on the relationship between income diversification and risk-taking has been contradictory; this paper adds to the body of knowledge by investigating whether IC moderates the relationship between income diversification and bank risk-taking.