Impact of market interest rate on profitability: Evidence from domestic

licensed commercial banks in Sri Lanka.

Thuraisingam Mayuri and Ratnam Vijayakumaran

Department of Financial Management, Faculty of Management Studies and Commerce, university of

Jaffna.

Abstract

This research study investigates the impact of market interest rate on profitability of domestic
licensed commercial banks in Sri Lanka. While the banking sector of Sri Lanka plays a vital
role in the Sri Lankan economy, commercial banks play dominant role in the banking sector
of Sri Lanka. Given the intense competition, profitability becomes one of the challenges faced
by the commercial banks to strengthen their financial positions and their fair returns. The
market interest rate is the interest rate offered most commonly on deposits in banks, other
interest bearing accounts, as well as loan and it is determined by the supply and demand for
credit. Although it has been argued that market interest rate is one of the important factors
that affect profitability of commercial banks, there is a lack of empirical research on the link
between market interest rate and profitability of Sri Lankan commercial banks. This study
attempts fill this research gap. This study considers eleven domestic banks for which data
were available for the period of nine years from 2007 to 2015. This study considers lending
rate as independent variable while net interest margin and return on asset as dependent
variables. In addition, capital ratio, bank size and loans to assets ratio are used as
controlling variables. Mainly, this study documents that market interest rate (lending rate)
positively and significantly affect profitability of commercial banks. Thus, market interest
rate is one of the important determinants of profitability of commercial banks in Sri Lanka.

Key words: Market interest rate, Profitability, Lending rate, Net interest margin, Return on
assets, Commercial banks.