The Influence of Asset Quality on Financial Performance: Evidence from Sri Lankan Banking Industry

Abstract

The banking industry of Sri Lanka is now being burdened by the increasing levels of Non-Performing Loans (NPLs) during and after the COVID-19 and subsequent economic crisis. The objectives of this study were to investigate the influence of asset quality on the financial performance of the banking industry and to identify the relationship between asset quality and the financial performance of the banking industry in Sri Lanka. The asset quality was measured by the Net NPLs to Total Loans and Advances (NNPLTLA), Total Provision Coverage Ratio (TPCR), Foreign Currency Denominated Loans to Total Loans and Advances (FCDLTLA) and Investments to Total Assets (ITA). The financial performance was measured by the Return on Assets (ROA), Return on Equity (ROE), Efficiency Ratio (ER) and Net Interest Margin (NIM). The data was extracted from the data sheets of Central Bank of Sri Lanka (CBSL) spanning the period from the year 2008 Quarter 1 to 2021 Quarter 3. For this purpose, a time-series data of 55 observations was used. An exploratory research design was adopted in this study. The analysis revealed that NPLTLA was statistically significant and negatively influenced on ROA and ROE. The NPLTLA was statistically significant and positively influenced on ER and NIM. The FCDLTLA was statistically significant and negatively influenced on ROA, ROE and NIM while negatively insignificant on ER. The results further indicated that the TPCR had insignificantly related with ROA, ROE and ER and statistically significant and positively influenced on NIM. The ITA had insignificantly influenced on ROA and ROE. The ITA significantly and negatively influenced on ER and Nim. The findings of this study will be useful to the banks of Sri Lanka, equity investors and future researchers since it uses the time series data of banking industry to investigate the influence of asset quality on profitability