Bank Financial Performance and Stability in the Western Balkans: Do Income Diversification and Market Concentration Matter?

This study examines the relationship between income diversification, market concentration, and bank performance using a panel of 73 commercial banks from six Western Balkan countries over the period 2011 to 2024. Bank and year fixed effects models are employed to estimate conditional associations between diversification, market structure, profitability, risk-adjusted performance, and stability. Three main findings emerge. First, a higher share of net interest income is associated with lower contemporaneous returns on assets and equity. Second, larger banks show stronger performance in three of the four outcome specifications. Third, market concentration, measured by the five-bank concentration ratio (CR5), is negatively and significantly associated with return on equity and negatively but only marginally with return on assets, whereas the Herfindahl Hirschman Index (HHI) and the HHI-based income diversification measure do not show robust relationships with profitability, risk-adjusted performance, or stability across four alternative inference methods. Overall, the results suggest that simple measures of banks' income structure and market concentration provide greater explanatory power than composite diversification indices in relatively underdeveloped banking systems. These findings should be interpreted as conditional associations rather than causal effects and indicate that competitive market conditions, rather than income diversification policies, are more relevant for understanding bank performance in the Western Balkans.