Evaluating the Efficacy of Risk Management Practices and Their Necessity for Enhancing the Profitability of Financial Institutions in Sri Lanka

Aims: This study aims to assess the effectiveness of credit and liquidity risk management practices employed by banking and non-banking financial institutions in Sri Lanka prior to the economic crisis that began in 2022, and to determine whether these practices contribute to enhancing profitability.

Study Design: The investigation employed quantitative research utilizing time series data.

Place and Duration of the Study: The study collected annualised quarterly data between 2014 and 2021 from the Central Bank reports of Sri Lanka.

Methodology: The study utilised a multiple regression model using EViews software.

Results: The findings revealed that banking and non-banking financial institutions in Sri Lanka demonstrated effective credit risk management practices, which significantly contributed to enhancing profitability. Conversely, inadequate liquidity risk management practices in both types of financial institutions significantly contributed to reducing profitability. Moreover, the financial institutions yielded very low profits relative to total assets during the study period.

Practical Implications: The findings offer practical insights for financial institutions, underscoring the importance of maintaining effective credit and liquidity risk management practices to enhance profitability.

Research Limitations: Data collection began in the first quarter of 2014, coinciding with the Central Bank's publication of comprehensive indicators for non-banking financial institutions from the fourth quarter of 2013 onwards. The data collection extended until the end of 2021. This timeframe was selected due to the adoption of more liberal credit policies by financial companies and the onset of liquidity challenges in 2022 resulting from the economic crisis in Sri Lanka.

Originality: This study is the first to compare the impact of credit and liquidity risk management practices on profitability between banking and non-banking financial institutions in Sri Lanka.