Determinants of Credit Risk: Based on Internal Bank Factors of the Commercial Banks in Sri Lanka

Abstract

This study aims to identify and analyze the internal determinants of credit risk in Sri Lankan commercial banks, focusing on factors such as bank size, annual loan growth, management efficiency, profitability, capital adequacy, and liquidity. The research covers a sample of 15 commercial banks in Sri Lanka from 2017 to 2023. Secondary data from audited financial reports and the Central Bank of Sri Lanka were analyzed using a panel Tobit regression model. The methodology includes descriptive statistics, correlation analysis, and random effects Tobit regression to assess the impact of bank-specific factors on credit risk, measured by the non performing loan ratio (NPLR). The findings reveals that management efficiency (ME) and loan-to-deposit ratio (LDR) significantly impact credit risk, with ME and LDR showing consistently significant relationships with NPLR. Bank size (BS) also has a notable positive effect on credit risk, whereas annual loan growth rate (ALGR), return on equity (ROE), and capital adequacy ratio (CAR) exhibit weaker correlations. The results highlight the importance of effective risk management practices, prudent lending, and optimal liquidity in mitigating credit risk. The findings underscore the need for robust risk management frameworks and prudent financial practices to enhance stability in Sri Lanka's banking sector. Implementing recommendations such as strengthening risk management strategies, adopting cautious lending practices, and maintaining optimal liquidity are crucial for improving resilience against credit risks and supporting sustainable growth