Abstract:

Banking industry contributes significantly to economic development through savings mobilization, credit provision, and the maintenance of financial stability. In Sri Lanka, Licensed Commercial Banks (LCBs) play vital role for the country’s financial system through their deposit mobilization and lending activities. An economic instability, inflationary pressures, liquidity constraints, growing level of non-performing loans created considerable challenges of sustaining bank profitability, an effective management of loans and deposits has become a critical concern for commercial banking institutions, this study investigates the impact of Loan-to-Deposit Ratio (LDR) on the profitability of Licensed Commercial Banks in Sri Lanka. A quantitative research approach was employed using secondary data obtained from the published annual reports of ten selected Licensed Commercial Banks in Sri Lanka covering the period from 2005 to 2021. Bank profitability was measured using Return on Assets (ROA), while the Loan-to-Deposit Ratio (LDR) was utilized as the primary independent variable. Furthermore, Non-Performing Loans (NPL) and Bank Size (BS) were incorporated as control variables. The relationships of LDR and bank profitability was examined using descriptive statistics, correlation analysis, and panel regression techniques. Based on the results by Hausman test, the Random Effects Model was selected as the most appropriate estimation model. The findings indicate that the Loan-to-Deposit Ratio has a statistically significant negative impact on the Return on Assets of Sri Lankan commercial banks. The results further suggest that an increase in lending activities relative to deposits may adversely affect profitability due to high liquidity risk and financial instability. Non-Performing Loans and Bank Size also exhibited negative associations with profitability, although these relationships were not statistically significant and maintaining excessively high Loan-to-Deposit Ratios can negatively influence the financial performance of commercial banks in Sri Lanka. The study recommends that commercial banks maintain an appropriate balance between loans and deposits while strengthening liquidity management and credit risk management practices to enhance profitability and ensure financial stability.