THE EFFECT OF NON-PERFORMING LOANS ON THE PROFITABILITY OF COMMERCIAL BANKS IN SRI LANKA

Kapilarathne M.Y.G.J.A.C¹ and Weligamage S.S²

¹²Department of Finance, Faculty of Commerce and Management Studies,
University of Kelaniya, Kelaniya, Sri Lanka

¹jeewanthaanil5@gmail.com, ²susima@kln.ac.lk

DOI: 10.57075/jaf922208

ABSTRACT

Sri Lanka commercial banks have remained with persistent challenges in managing non-performing loans that are considered to have effects on banks’ profitability and the government has developed different ways of reducing non-performing loans. The purpose of this study was to find out the effects of nonperforming loans on the profitability of commercial banks in Sri Lanka.  The study used commercial banks registered and operational in Sri Lanka at Central Bank Sri Lanka in the year 2018. Profitability calculated by the return on assets is used as a dependent variable and as an independent variable, non-performing loans measured by non-performing loans ratio are used. Capital adequacy, operational efficiency, and liquidity are used as control variables to enhance the validity and accuracy of the tests. The control variables used are part of the CAMEL factors that also influence commercial banks’ profitability. The study selected 11 commercial banks covering the period of 2014 to 2018. To analyze and draw conclusions and recommendations, the analysis also used secondary data. Descriptive Statistics, Multiple Linear Regression, and Pearson Correlation were used for data analysis and Stata has been used as statistical software to analyze the collected data. Findings indicated that there is a negative effect of the nonperforming loans ratio on return on assets, confirming that non-performing loans negatively affect the profitability of commercial banks in Sri Lanka.  There is a positive and significant relationship between Return on Assets and Capital Adequacy. When considering the relationship between Return on Assets and Liquidity there is a positive insignificant relationship and there is a negative relationship between Return on Assets and Operational Cost Efficiency. This study concluded that the managers of Commercial banks in Sri Lanka have to work hard to enhance the profitability of commercial banks and reduce occurrences of nonperforming loans. This paper, therefore, provides insight to commercial banks, the central bank, and other stakeholders on the effect of nonperforming loans on the profitability of commercial banks in Sri Lanka and provides a basis for further research.

Keywords: Non-Performing Loans, profitability, Sri Lanka, Commercial banks.