Moderating Effect of Bank Size on the Factors Affecting the Financial Performance of Domestic Commercial Banks in Sri Lanka

Abstract

This study examines the impact of internal bank-specific factors on the financial performance of domestic commercial banks in Sri Lanka, with a particular focus on the moderating role of bank size. Employing panel data from thirteen licensed commercial banks listed on the Colombo Stock Exchange over the period 2014 to 2023, the analysis examines the effects of capital adequacy, cost-to-income ratio, liquidity, and non-performing loans on two key performance indicators, which are net interest margin and return on assets. Fixed and random effects panel regression models were estimated, incorporating interaction terms to capture the moderating impact of bank size, and the Hausman test was used to determine model appropriateness. The findings reveal that internal determinants significantly affect bank performance. Higher cost inefficiency and greater credit risk are negatively associated with return on assets, while liquidity demonstrates a positive association. Capital adequacy exhibits a marginally positive relationship with net interest margin, but a significant negative effect on return on assets, indicating a trade-off between financial stability and profitability. Bank size exerts both a direct negative influence on return on assets and a significant moderating effect. Specifically, large banks exhibit reduced sensitivity to the adverse impacts of cost-to-income ratio and non-performing loans and derive diminishing performance benefits from liquidity and capital adequacy. These results suggest that the effectiveness of managerial strategies and regulatory frameworks may vary by institutional scale. The study contributes to the literature by highlighting the conditional nature of internal performance linkages and the importance of scale-sensitive policies in enhancing bank profitability. Future research should explore these dynamics in broader samples and macroeconomic contexts.