Impact of Bank-Specific and Macroeconomic Factors on the Net Interest Margin of Financial Institutions in Sri Lanka

Banks and other deposit-taking financial institutions play a crucial role in any country's economy. The Interest Spread and Net Interest Margin (NIM) in Sri Lankan financial institutions are considerably higher than in other regional countries, indicating high intermediation costs. This paper aims to identify the primary factors contributing to maintaining a higher margin in the sector. Credit risk, liquidity risk, firm size, operational expenses, and earning ability were considered as bank-specific explanatory variables, while interest rate, inflation rate, and economic growth rate were used as macroeconomic explanatory variables. The selected sample comprised seven Licensed Commercial Banks (LCBs), three Licensed Specialized Banks (LSBs), and five Licensed Finance Companies (LFCs) based on their total assets. Data were collected from published secondary sources over a period of 10 years (2009-2019). The data for 2020, 2021, and 2022 were omitted due to the negative impact of COVID-19 and the economic crisis in the country. Multiple regressions with a fixed-effect model were employed to identify significant variables. The results reveal that firm size, credit risk, interest rate, and economic growth are significant across the entire sample. However, firm size emerges as the only industry-specific significant variable in Licensed Finance Companies (LFCs).