IMPACT OF CREDIT RISK AND BANK-SPECIFIC FACTORS ON THE FINANCIAL PERFORMANCE OF LICENSED BANKS IN SRI LANKA

Abstract

The objective of the study is to examine the impact of credit risk and bank-specific factors on the financial performance of licensed banks in Sri Lanka during the period of seven years (2015 - 2021). In the empirical investigation, return on assets and return on equity are used to measure financial performance while non-performing loans and capital adequacy are proxies for credit risk. Cost efficiency, average lending, loan-to-deposit ratio, and bank size are considered bank-specific factors. Seventeen licensed commercial banks and five licensed specialized banks are taken as samples of this study, and data is collected from annual reports of licensed banks in Sri Lanka during the period from 2015 to 2021. Panel data regression analysis is employed to examine the hypotheses. Results of the study revealed that non-performing loans have a negative impact on banks’ financial performance in terms of return on assets of licensed banks whereas average lending has a positive impact on banks’ financial performance in terms of return on assets. Other variables such as capital adequacy, cost efficiency, loan-to-deposit ratio, and bank size have not shown any significant impact on the financial performance of licensed banks. The output of the study may be useful to the bank lending unit’s decision-makers, investors, and economic policymakers of the country. The Banks should seek mechanisms to improve their risk management capacity efficiency and quality lending to remain competitive in the market.