In Sri Lankan context some studies were carried out based on the internal and external determinants on the bank profitability. Those studies examined how bank specific determinants and macroeconomic determinants collectively impact on the profitability of commercial banks in Sri Lanka. (Weerasinghe & Perera, 2013)investigate the impact of bank specific and macroeconomic determinants on the commercial bank profitability of Sri Lanka during the period of 2001-2011 by carrying out a multiple panel regression. The results clearly show that size, Liquidity, operational cost and interest rate have contributed significantly for the profitability of commercial banks operating in Sri Lanka which is measured by ROA. Capital adequacy ratio which had reported a negative insignificant relationship with ROA which is not in line with the prior studies.
Looking at the effect of the liquidity and operational efficiency, it is revealed that banks with higher efficiency with a lower liquidity would be contributed for higher profitability. Bank credit risk does not have an impact on bank profitability. When considered the macroeconomic variables, interest rate is clearly affects to profitability. High interest rate scenario reduces credit expansion by resulting lower profitability. However, the GDP growth variable does not significantly affects the bank profitability but has reported a positive relation with the ROA.
in addition to that Result was found that the large banks are recorded more profits due to economies of scale than the banks which are well sound with regulatory capital ratio. Further the results from the panel regression suggest that the liquidity and operating cost efficiency banks were negatively related to the commercial bank profitability in Sri Lanka. in addition, interest rate found to be having a significant impact on the bank profitability with a negative relationship between the return on assets of a bank implying that lower interest rate scenario would accounted a higher level of profitability with the expansion of banking activities. (Sivaperumaan, 2013)examined the determinants of profitability in the private commercial banks in Sri Lanka. In this study, internal variables namely capital ratio, activity mix, size, overheads and liquidity are considered as variables which have impact on banks’ profitability.
The results reveal capital ratio, size and liquidity have positive impact on banks’ profitability whereas activity mix and overheads have negative impact. The results reveal that the capital ratio has significant positive relationship with the profitability. It suggests that a bank with a sound capital position is in a position to pursue business opportunities more effectively, thus achieving increased profitability. At present, a very peaceful business environment is prevailing in Sri Lanka and perfect capital markets are also functioning. Therefore, the quality capital base of banks might have helped the banks to attract new customers to invest their money in the banks which in turn might have led the banks to perform well in their businesses.
Further, when the banks earn high profits the banks can reinvest the money in the profitable investment after meeting the CAR requirement which in turn increase the quality of capital as well as the profitability of the banks. The activity mix is found to be insignificance variable in the model since it has a negative impact on profitability as per the results obtained. As mentioned earlier, the fee based activities are less risky than the interest based activities. The results suggest that when banks move from these interest base activities to fee base activities, the banks’ performance tends to decrease. As found in the other studies and as expected, Size of the banks has a positive and significant impact on the profitability of the banks. The results suggest that larger banks achieve a higher return on assets by enjoying economies of scale. At present, most of the Sri Lankan banks have extended their branch network to the Northern and Eastern province of the country, particularly after civil war. This situation might have influenced the profitability of the banks through the expanded branch network operations.
It is evident that the asset quality of banks is now improving. (Central Bank of Sri Lanka, 2010) The expanded branch network might have increased the profitability of the banks which, in turn, might have increased the asset quality. The results reveal that the operating expenses management is factor that has a great impact on the profitability since it is a highly significant variable in the model. It is found that it has negative relationship with the profitability. This will indicate a decrease in profit due to the increase in the overhead expenses. The overhead expenses may have positive or negative impact on the profitability. If the overhead expenses are expensed in a productive manner such as promotion campaign etc.
, positive relationship can be expected. In Sri Lanka, after the war the banks are expanding their network to Northern and Eastern provinces and a considerable amount of money was spent on promotion campaign in order to market their varieties of products among the customers. However, the impact of the promotion campaigning seems to be ineffective. Finally, the liquidity ratio affects the banks’ performance positively and significantly, as per the empirical results. This is a contradictory result than expected. Central Bank of Sri Lanka has reduced the Standard Liquidity Asset Ratio (SLAR) in order to expand the credit facilities in the country. The result shows that liquidity in the banks has been utilized effectively.
It seems that the liquidity position has been used for credit expansion and due to this the banks were in a good position to earn income.Overall, the existing literature provides credible evidences of the effect of internal and determinants on bank profitability, but the effect of the macroeconomic indicators is not adequately dealt with. The time relating to the panels used in empirical studies is usually too small to capture the effect of explanatory variables related to the macroeconomic environment. So it is expected to find out the impact from both bank specific and macroeconomic indicators on the profitability.