Abstract:
Financial institutions play a massive role in achieving the economic growth of a
country. Here, the commercial bank’s contributions seem vital because commercial
banks lend to the people who wish to invest. In this scenario, banks have a threat of
unpaid l oans. It may adversely affect the profitability of the bank because of the loss
of interest income. Therefore, it is critical to understand the relationship between
credit risk and profitability. However, previous literature does not indicate a
straightfor ward relationship between credit risk and profitability because there are
three different arguments on the same concept: negative relationship, positive
relationship, and neutral relationship. Hence, this study investigates the effect of
credit risk on pro fitability using all the commercial banks in Sri Lanka that operated
during the 2010 2020 period in order to fill this knowledge gap. Also, the main
objective of this study is to assess the relationship between credit risk and
profitability. The dependent variable of this study is profitability, and Return on
Equity (ROE), Return on Assets (ROA), and Net Interest Margin (NIM) were used to
measure it. Credit risk is considered the independent variable of the study and it was
measured using the Non Performing Loan Ratio (NPLR). Firm size, bank age, and
GDP growth were used as control variables. The total assets of the bank, years since
incorporation, and GDP growth rate are the measurements of these three control
variables respectively. In order to assess the relationship between credit risk and
profitability, a regression model was used. Ultimately, according to the regression
model, this study suggests that non performing loans positively affect profitability
measured using return on equity and return on asse ts. However, the non performing
loans do not affect profitability measured using net interest margin
