The Impact of “CAMEL Composite Index” on Income Diversification: A Case Study of the Iranian Banking System

Investigating banks’ status has always been a concern to its management and regulatory decisions, which can be carried out by means of income diversification and CAMEL composite. The importance of income diversification is to decline the operation risk. The soundness of banking is also another essential component in the banking industry that can be evaluated by CAMEL. This article’s two primary goals are computing CAMEL composite index and investigating the relationship between income diversification and banking soundness, using CAMEL composite index within the financial statements of 16 Iranian banks between the years 2010 to 2017. This study applied an exploratory factor analysis (EFA) to compute the CAMEL composite calculated by arithmetic mean in the previous studies. In addition, the Herfindahl-Hirschman index (HHI) has been used to calculate income diversification. The generalized method of moments (GMM) panel model has been utilized to study the relationship between variables. The result of EFA confirms two factors: financial ability and financial performance. The result of GMM panel model shows a positive and significant relationship between financial ability and financial performance on income diversification.