Intellectual capital, income diversification and financial performance of Commercial Banks In Kenya

Abstract

In an era of knowledge-based economies, intellectual capital has gained prominence as a critical financial performance driver. However, extant literature shows that the effect of intellectual capital on financial performance is unclear. Whereas theoretical assertions argue that firms can leverage on knowledge based resources through diversification, empirical evidence in the existing literature is limited. Thus, guided by the modern portfolio theory, the resource-based view theory, and the dynamic capabilities theory, this study sought to examine whether income diversification mediates the relationship between intellectual capital and financial performance of Kenyan commercial banks. Specifically, the study examined the effect of; human capital, process capital, innovation capital, and customer capital on Kenyan commercial banks' financial performance. The study also examined the mediating effect of income diversification on the relationship between human capital, process capital, innovation capital, customer capital, and commercial banks' financial performance in Kenya. The study adopted a longitudinal and explanatory research design since it sought to establish causal relationships between the research variables using panel data analysis. The target population consisted of the 42 commercial banks in Kenya, and data was for the period 2008 -2017. Data was extracted from the individual bank’s audited annual reports and the Central Bank of Kenya’s yearly reports. The data were analyzed through descriptive and inferential statistics. The study found that human capital (β=0.377, ρ<0.05), process capital (β=0.119, ρ<0.05), innovation capital (β=0.077, ρ<0.05), customer capital (β=0.379, ρ<0.05), and income diversification (β=0.130, ρ<0.05) had a positive and significant effect on the financial performance of commercial banks in Kenya. Further, the study found that income diversification mediated the relationship between human capital (β=0.068, ρ<0.05), process capital (β=0.048, ρ<0.05), innovation capital (β=0.027, ρ<0.05), customer capital (β=0.068, ρ<0.05), and financial performance. This study's findings are supported by the resource-based view theory, emphasizing the importance of knowledge-based resources to firm performance. The portfolio theory that posits income diversification improves banks' financial performance. The study concluded that intellectual capital had a positive and significant effect on Kenya's commercial banks' financial performance. Further, the research established that income diversification partially mediated the impact of intellectual capital on commercial banks' financial performance, making a novel contribution to the existing literature. The study recommends that regulators relax laws limiting the extent to which banks can engage in revenue diversification, allowing banks to reap the benefits of optimal income diversification. Additionally, the study proposes mandatory disclosure of intellectual capital. The study recommends that banks consider income diversification to cushion against interest income volatility and exploit knowledge resources for managerial implications.