The Impact of Loan Portfolio Diversification on Bank’s Credit Risk: Evidence from Sri Lanka

Abstract

Introduction: This study investigated the impact of loan portfolio diversification on the risk of commercial and specialized banks in Sri Lanka. Although the impact of credit diversification on enhancing fundamental stability and competitiveness needs to be considered, research on credit portfolio diversification in Sri Lanka is limited. Therefore, this study is helpful in that regard.

Methodology: The sample consisted of 12 Domestic banks in Sri Lanka and the research period is 2009–2023. The data for the study is collected from secondary sources, such as the Annual report, CBSL report, and Sustainability report. The research philosophy of this research is positivism. The collected panel data is analyzed using the STATA software.

Findings: The findings suggest that product-based diversification of the loan portfolio has a significant impact on NPLR, while industry-based diversification of the loan portfolio does not appear to have a significant impact. These findings may be valuable for banks in managing their capital adequacy, deposit levels, and cost efficiency to improve their financial performance and reduced credit risk.

Conclusion: The study investigated impact of loan portfolio diversification on credit risk of banking industry in Sri Lanka. This study analysis has two independent variables, three control variables and two dependent variables. There are non-performing loan ratio and Loan loss provisioning ratio as dependent variable and, as independent variables, there are HHI index of product wise (HHIp) and HHI index of industry wise (HHIs). Here is data analysis through the STATA-13 software. Further research on loan portfolio diversification and its impact on credit risk in the Sri Lankan banking sector could explore several avenues beyond the current study. First, future studies could delve deeper into the role of macroeconomic variables such as inflation, exchange rates and GDP growth. Another area for further research is the impact of non-traditional banking products, such as digital loans and microfinance, on credit risk.