Institutional Level Drivers of Non-performing Loans: A Study of Licensed Commercial Banks in Sri Lanka

Loans are considered the major source of income for banks compared to other revenue generating sources. The increasing rate of non-performing loans is a threat to the banks since it exposes the banks to many associated risks, such as credit risk, default risk, and liquidity risk, and affects the financial condition of the banks. In general, non-performing loans could be caused by two major factors, namely institutional factors and macro-level factors. However, specific institutional factors could be controlled by the banks compared to macro-level factors. As a result, this study primarily focused on the impact of credit, due diligence practices and internal risk management within the lending division on the loan default rates of licensed commercial banks located in Colombo district in Sri Lanka. The sample of the study covers staff of thirteen local licensed commercial banks located at Colombo district in Sri Lanka, excluding other foreign commercial banks due to the differences in reporting methods and standard operating procedures. This study follows a deductive research method, using multiple linear regression analysis to identify the impact of credit assessment and due diligence practices and internal risk management on loan default rates of commercial banks. The indicates that combination of credit assessment, due diligence practices, and internal risk management can significantly predicts NPL while credit assessment is the most influential factor.