Impact of Risk Management on Firms’ Financial Performance: Evidence from Licensed Commercial Banks in Sri Lanka

Abstract

Introduction: This study investigates how methods for risk management affect Sri Lankan commercial banks with permissions and their financial results. Effective risk management is now essential to maintaining the profitability and security of banks in a financial environment that is becoming more and more uncertain. The research focuses on key risk factors: nonperforming loans (NPL), loans and advance (LA), loan loss provision (LLP), liquidity ratio (LR), and return on equity (ROA). The study investigates financial statements from seven commercial banks out of the twenty-four commercial banks that are listed on the Colombo Stock Exchange. They are selected under the sufficient of data category and other banks excluded due to the insufficient of data.

Methodology: All the data collected as secondary data from annual report from 2019 to 2023 of each bank and the data analyzed by using regression analysis. The data set was analyzed using EVIEWS software. Furthermore, the firm’s performance measured by Return on Asset and risk management measured by loan loss provision, loans and advances, non-performing loans and capital adequacy ratio.

Findings: Loans and advances (LA) represent a critical role in improving financial performance, as the analysis shows that they have a statistically significant and positive impact on ROA. On the other hand, ROA is not significantly correlated with Loan Loss Provisions (LLP), Non-Performing Loans (NPL), Liquidity (LIQ), or the Capital Adequacy Ratio (CAR). While the model explains a moderate proportion of the variation in ROA, the adjusted R-squared suggests room for improvement in predictive accuracy. The overall model is statistically significant, with no evidence of autocorrelation in the residuals.

Conclusion: In conclusion, these findings highlight the urgent need for more empirical and theoretical research to strengthen the model's explanatory power, improve its predictive stability, and provide a more comprehensive, complex understanding of risk management's multiple influence on bank performance, operational efficiency, and financial stability.