The Impact of Capital Adequacy Requirements on Profitability of Licensed Finance Companies in Sri Lanka

Abstract

The Licensed Finance Companies (LFCs) have a higher risk portfolio compared to the banking industry of Sri Lanka. This study aims to examine the impact of capital adequacy requirements on the profitability of LFCs in Sri Lanka. Capital funds to deposits (CFD), Borrowings to equity (BE) and Core capital to risk weighted assets (CCR) are considered as capital adequacy requirements related measurements. Return on equity (ROE), Return on assets (ROA) and Interest income to interest expenses (IIIE) are considered as profitability measures of the LFCs. The study used a quantitative research approach. Based on the data during the sample period from December 2013 to June 2024, the time-series data were collected. The results revealed that only BE had positively significant impact on ROE. Using ROA as the proxy for LFCs’ profitability, it was found that BE and CCR had positively significant impact on ROA. Using IITIE as the proxy for LFCs’ profitability, it was found that only CCR had negatively significant impact on IITIE. The CFD was found to be insignificant with the profitability as measured by ROE, ROA and IITIE. The author suggests that further empirical studies should be conducted on capital adequacy requirements, which would be a source as it will help LFCs to improve their financial performance.