The Impact of Asset Quality on Profitability: A Panel Data Analysis of Domestic Commercial Banks in Sri Lanka

Abstract

This research attempts to determine the effects of asset quality on the banking profitability of commercial banks in Sri Lanka. This study is based on secondary data for the period 2008 to 2016, which are obtained from annual reports published by 9 commercial banks in Sri Lanka. The analysis based on panel fixed effect regression indicates that asset quality factors had a negative impact on the bank’s profitability at a statistically insignificant level. This was mainly because asset quality does not solely determine the profitability of banks. Other factors such as capital adequacy, management efficiency, earnings performance and liquidity may also contribute to profitability. Based on the findings, this study recommends that improved investment assets levels and the low rate of non-performing assets needs to be realized through credit risk identification, measurement, monitoring and controlling, in order to achieve high asset quality levels. Accordingly, this study recommends that banks improve credit policy by obtaining collateral and adhering to strong credit risk assessment indicators by following post sanction risk monitoring mechanism.