Effect of US Subprime Crisis on Sri Lankan Commercial Banks: Does Ownership Matter?

Abstract

Even though Sri Lankan financial system weathered the US subprime crisis, ripple effects of the crisis were visible sparingly. For example, a famous financial institution collapsed while a systemically important bank faced a severe distress along with the crisis. Generally, it appears that the distressed financial institutions were privately owned. Despite the fact that the effect of ownership on bank performance have been well documented, the resilience of different ownership groups to external and internal crisis has been less researched particularly in Sri Lanka. Therefore, this study, drawing upon a quarterly dataset during 2005Q4 and 2011Q4 on ten commercial banks in Sri Lanka, explored whether the US subprime crisis has affected different ownership categories diversely. Even though the findings are inconclusive, evidence suggest that foreign banks, in general, tend to bring external vulnerabilities into the domestic financial system irrespective of the presence of a crisis. Importantly, the performance of foreign banks weakens easily during an external crisis compared to both domestic private banks and state-owned banks. State-owned banks demonstrated the highest degree of resilience whereas domestic private banks also have experienced difficulties during the crisis period. However, since the market share of foreign banks is still limited in Sri Lanka, their performance fluctuations have not caused major issues in the overall financial system. Findings of this study emphasize the importance of maintaining a balanced financial system through preserving different ownership types within the financial system. Concurrently, this study can be considered as the first of its kind in relation to Sri Lankan context.