Determinants of Non-Performing Loans: Evidence from Sri Lanka

Abstract

Purpose: The increasing trend of non-performing loans in Sri Lanka threatens the banking system. This study attempts to identify the determinants of non-performing loans in licensed commercial banks in Sri Lanka to fill the void in the finance research arena.

Methodology: This study is carried out with a sample of eight licensed commercial banks using macroeconomic factors and bank-specific factors: the real interest rate, annual GDP growth rate, annual inflation rate, exchange rate, unemployment rate, the efficiency of the bank, bank size, lending rate, and ROA. Financial data were analyzed for the period of 2008-2018 using panel data regression analysis.

Findings: Results show that GDP growth rate, Exchange rate, Unemployment rate, inflation rate, and bank size have a significant effect on non-performing loans in the Sri Lankan banking industry. However, bank efficiency and return on asset (ROA) do not significantly correlate with NPLs. Among these relationships, only the exchange rate shows a positive relationship with the NPL, whereas all other variables show a negative relationship.

Implications: According to the study's findings, it is recommended that Sri Lankan commercial banks have their focal point on credit risk management based on maximizing return on its assets while keeping its non-performing loans within acceptable limits.