Banking Innovations and New Income Streams: Impact on Banks’ Performance

Banks in India have focused on non-interest income streams to complement their income from traditional interest earning activities for some years now. This move to innovation adoption and new income streams has been more pronounced for new private and foreign banks, while there appears to have been certain hesitation on the part of public sector and old private banks. This article studies the impact of the move to new income streams and the consequent rising diversification on performance (as measured by profitability and stability of income) for Indian banks. A comparative analysis of income generated from these income streams for different bank groups in India shows that new private banks and foreign banks in India have been more successful than public sector banks in generating a greater proportion of their income from non-interest and fee-based sources. However, this increasing diversification cannot be linked to better risk-adjusted performance in the Indian context. Using multiple regression analysis, the impact of diversification and increasing share of fee-based income on profitability and risk-adjusted profitability is questioned for all banks in India over the period 2005–2012. The article finds that the rising share of fee-based income and non-interest income in total income and diversification has a positive impact on profitability, but the impact on risk-adjusted performance and hence stability is not statistically significant. While the results show a positive impact of diversification on profitability, the article underlines that the impact direction of diversification measures may be negative, which is in agreement to what many studies have shown in the US, European, Australian and Indian contexts. This article considers the impact of diversification in non-interest income separately from diversification in total income. This diversification score helps to know if the banks are generating their non-interest income from only fee income or only their own investments or have they diversified the non-interest income generation by focusing on both. Importantly, there is a positive impact of increasing share of ‘fee income’ in both total income and non-interest income on profitability as well as risk-adjusted measures. The results underscore that while public sector banks need to generate more income from fee-based activities, it would be imperative to choose sources of fee-based income that remain stable and have a positive impact on risk-adjusted measures.