THE MEDIATING ROLE OF FINANCIAL PERFORMANCE ON THE RELATIONSHIP BETWEEN LOCATION DIVERSIFICATION AND FINANCIAL STABILITY OF COMMERCIAL BANKS IN KENYA

Abstract

The banking environment has become increasingly competitive, leading commercial banks to strengthen their focus on diversified activities and business lines. Driven by factors like market saturation, the need to build new revenue sources, and the pursuit of profitability, they are expanding into new geographic markets. The objective of this study was to establish the mediating role of financial performance on the relationship between location diversification and financial stability among commercial banks in Kenya. The research adopted an ex post facto correlational research design, covering 38 commercial banks and analyzing panel data from the period 2014 to 2023. Location diversification was measured by the natural logarithm of the number of bank branches in different geographical areas. Financial performance was measured using Return on Assets (ROA), while financial stability was assessed using Altman's Z-Score, which measures a bank's distance to default. Data analysis was conducted using E-Views statistical software, and the study hypotheses were tested using F-test and multiple linear regression analysis. Results showed that location diversification does not have a significant effect on the financial stability of commercial banks in Kenya (β = -0.0501, p-value = 0.488. Mediation analysis revealed that financial performance does not mediate the relationship, as location diversification had no significant effect on the mediator, financial performance (β = 0.0126, p = 0.8387). However, financial performance itself had a significant, direct positive effect on financial stability (β = 0.0434, p < 0.01). It was thus concluded that financial performance does not mediate the relationship between location diversification and financial stability of commercial banks in Kenya. The findings support the agency theory, which highlights conflicting interests between parties in the context of location diversification. The study therefore recommends that commercial banks should undertake location diversification only if it is expected to lower risk, improve financial performance, and enhance financial stability.