EFFECT OF MICROFINANCE ON

PROFITABILITY OF COMMERCIAL BANKS OF

SRI LANKA

By

H.P.P. Gangabadage

MF/2009/2350

Department of Accounting and Finance

August 2013

Dissertation Presented to the Faculty of Management and Finance

of University of Ruhuna

in Partial Fulfillment of the Requirements for the Degree of

Bachelor of Business Administration

 Acknowledgement

I would like to convey my sincere gratitude to my supervisor Dr. M.K. Wanniarachchige

for the continuous guidance and valuable advices during the whole period of the
dissertation. Without his extreme encouragement, I would not be able to complete this
successfully.

I express my heartfelt thanks to Ms. Chinthika Amarasekara, Vice President

(Accounting & Reporting) DFCC Bank, for all the support given in completion my
research work.

I thank my beloved parents, brother, and sisters for their endless support and
wishes in all the events in my life.

I am also grateful to all the lecturers of University of Ruhuna who taught me

during the past four years and all the friends who always encouraged me all the time.

i
 Dedication

I would like to dedicate this to my beloved parents who are always behind me to support
and guide me in all the things in my life.

ii
 Table of Content

Acknowledgement ............................................................................................................... i
Dedication ........................................................................................................................... ii
List of Table ........................................................................................................................ v
List of Figures .................................................................................................................... vi
List of Acronyms .............................................................................................................. vii
Declaration ....................................................................................................................... viii
Certification ....................................................................................................................... ix
Abstract ............................................................................................................................... x
1 INTRODUCTION ....................................................................................................... 1
1.1 Background of the Study ...................................................................................... 1
1.2 Research Problem ................................................................................................. 2
1.3 Research Question and Objectives ....................................................................... 2
1.4 Methodology ........................................................................................................ 3
1.5 Significance of the study ...................................................................................... 3
1.6 Limitations of the Study ....................................................................................... 3
1.7 Summary and Organization of Chapters .............................................................. 4
2 LITERATURE REVIEW ............................................................................................ 5
2.1 Introduction .......................................................................................................... 5
2.2 Microfinance ........................................................................................................ 5
2.3 Competition in Microfinance market in Sri Lanka .............................................. 6
2.4 Microfinance and Profitability of Commercial Banks ......................................... 7
2.5 Summary .............................................................................................................. 9
3 METHODOLOGY .................................................................................................... 10
3.1 Introduction ........................................................................................................ 10
3.2 Research Design ................................................................................................. 10
3.3 Sample and Data Analysis.................................................................................. 12
3.4 Summary ............................................................................................................ 12
4 DATA ANLYSIS AND DISCUSSION .................................................................... 14
4.1 Introduction ........................................................................................................ 14

iii
 4.2 Exploratory Data Analysis ................................................................................. 14
4.3 Descriptive Statistics of the variables ................................................................ 16
4.4 Impact of microfinance on profitability of commercial banks ........................... 16
4.5 Summary ............................................................................................................ 17
5 CONCLUSION AND IMPLICATONS .................................................................... 18
5.1 Introduction ........................................................................................................ 18
5.2 Key findings of the study ................................................................................... 19
5.3 Conclusion.......................................................................................................... 19
5.4 Implications ........................................................................................................ 20
References ......................................................................................................................... 21

iv
 List of Table

Table 4. 1 Descriptive Statistics........................................................................................ 16

Table 4. 2 Regression Results ........................................................................................... 17

v
 List of Figures

Figure3. 1 Conceptual framework .................................................................................... 11

figure4. 1 Net Interest Income & Micro Lending ............................................................. 15

figure4. 2 PBT & Micro Lending ..................................................................................... 15

vi
 List of Acronyms

ADB - Asian Development Bank

BOC - Bank of Ceylon

GTZ - Deutsche Gesellchaft for Techniche Zusammenarbeit

(German Agency for Technical Cooperation)

HNB - Hatton National Bank

LA - Loans & Advances

MFI - Microfinance Institutions

ML - Micro Loans

OLS - Ordinary Least Square

PBT - Profit Before Tax

ROA - Return on Assets

ROE - Return on Equity

SME - Small & Medium Entrepreneurs

vii
 Declaration

I hereby declare that this dissertation is my own work and effort and that, to the best of

my knowledge and belief, it contains no material previously published or written by

another person nor material which has been accepted for the award of any other degree or

diploma of the university or other institute of higher learning, except where due

acknowledgment has been made in the text.

Signature of the student: ________________________________

Name of the student: H.P.P. Gangabadage

Registration number of the student: MF/2009/2350

Date: 10/02/2014

viii
 Certification

This is to certify that this dissertation submitted by H.P.P. Gangabadage (MF/2009/2350)

in partial fulfillment of the requirement for the Degree of Bachelor of Business
Administration in Accounting at the Faculty of Management and Finance of the
University of Ruhuna is a record of the own work carried out by the student under my
supervision. This dissertation has been submitted with my approval.

____________________________

Supervisor

Dr. M.K. Wanniarachchige

Department of Accounting and Finance

Faculty of management and Finance

University of Ruhuna

____________________________

Head, Department of Accounting and Finance

Faculty of management and Finance

University of Ruhuna

ix
 Abstract

Microfinance is an effective development tool, which empowers the poor and small-scale
entrepreneurs who have limited access to the formal banking services and capital
markets. Microfinance provides small-scale financial services such as micro loans,
savings, insurance, and other financial services with least legal requirements. Number of
government institutions, non-government microfinance institutions, and other financial
institutions such as banks are involved in the microfinance market.
License commercial banks play an important role in the financial system of the
country. Their contribution to the stability of the financial system and the development of
the country enhanced with the entry to the microfinance market. State owned commercial
banks engage in providing microfinance services mainly to implement the poverty
alleviation policy of the government, while private banks seek public image or profits.

Limited researches could found in the literature addressing the profit motive of
commercial banks entering the microfinance market. Therefore, the aim of conducting
this research was to measure the impact of microfinance on the profitability of
commercial banks. For the fulfillment of this research objective, the study obtained
secondary data from published annual reports of five commercial banks including two
state banks over the period of four years 2009-2012. These data were analyzed using
regression and exploratory data analysis to interpret the results.
Data analysis revealed that the microfinance have a positive relationship with net
interest income and profit before tax of commercial banks. State owned banks are the top
players among the commercial banks in the microfinance market. They have the biggest
microfinance portfolio and they have been able to earn the highest profits though
provision of microfinance services. The main finding of the study was that the
microfinance does a significant impact on the profitability of commercial bank. This
finding would assist the decision makers of commercial banks in their decision-making
processes.
Keywords: commercial banks, microfinance, profitability

x
 CHAPTER 1

1 INTRODUCTION

1.1 Background of the Study

Microfinance provides financial services to Small and Medium Scale (SME)

entrepreneurs who have limited access to capital markets and banks. Further,
microfinance creates a support network within the community to ensure that the
borrowers succeed in their ventures (Roy, 2003). Therefore, microfinance has a
significant recognition as an effective development tool in reducing poverty and
empowering the SMEs.

Microfinance in Sri Lanka commenced in 1911 where the thrift and credit
cooperatives established under the Cooperative Credit Societies Ordinance of 1911. Since
then, the microfinance industry in Sri Lanka has grown rapidly and gained the attention
and support of both Government and non-government funding agencies. Since 22 percent
of the total population in Sri Lanka considered poor, there is a large market for
microfinance (Gant, et al 2002). GTZ (2009) has stated that, “Sri Lankan financial sector
is essentially a Micro finance market with over 80% of households having total
borrowings less than 100,000 LKR.”

Currently, different types of institutions are providing microfinance services

based on a wide range of microfinance models such as self-help group lending model,
individual lending model, etc. While an increasing number of specialized microfinance
institutions (MFIs) have shown that microfinance can be profitable, an increasing number
of banks have entered into the microfinance market. Among them, Hatton National
Bank’s Gami Pubuduwa (Village Awakening) is the oldest microfinance program offered
by a commercial bank in Sri Lanka. Since its commencement, the scheme has disbursed
over LKR 3.5Bn to around 70,000 micro entrepreneurs all over the country. However, for
many commercial banks and finance companies, microfinance is merely a fulfillment of
corporate social responsibility or an image building activity (GTZ, 2010).

1
 Even if a commercial bank attempts to ensure the corporate social responsibility
through microfinance services, the long-term viability of a microfinance program is
eventually determined by the contribution of microfinance to the profitability of the bank.
For example, if commercial banks continuously increase microfinance services, it implies
that microfinance is profitable (Curran, et al 2005).

1.2 Research Problem

According to GTZ (2009), most of the senior managers of private commercial banks
believe that the high costs associated with small transactions do not allow commercial
banks’ microfinance operations to be profitable. Meanwhile, Charitonenko and De Silva
(2002) have stated that, while commercial banks’ involvement in microfinance is limited,
none of their microfinance programs is profitable.
However, Young (2005) has stated that existing commercial banks in developing
countries have been able to prove their tremendous potential to act profitably in the
microfinance market. For example, a number of commercial banks in South Asian region
have shown promising results in terms of profits and growth over the past decade.
Even though there are different arguments concerning the profitability of
microfinance for commercial banks and a visible increase in commercial banks providing
microfinance services, only a limited number of studies have been conducted to
investigate the effect of microfinance services on the profitability of commercial banks in
Sri Lankan context. As a result, it has become difficult to make straightforward
recommendations concerning the involvement of commercial banks in microfinance
activities. Moreover, the formulation of strategies to make the microfinance activities of
commercial banks more profitable also has become cumbersome.

1.3 Research Question and Objectives

The study attempts to answer, “Does the provision of microfinance services affect the
profitability of commercial banks?

To this end, the study aims to,

1 Identify the importance of microfinance activities among other financial services

offered by commercial banks.

2
2 Measure the contribution of microfinance activities to profitability of commercial
banks.

1.4 Methodology

The Study obtained required data from the published annual reports of five commercial
banks selected based on random sampling during 2009-2012. Profit Before Tax (PBT)
was considered as the main profitability indicator for the purpose of the study.
Microcredit volume represents the involvement of the banks in microfinance activities. In
addition to the measurement of the impact on the PBT, the study also considered the
relationship of micro lending with Interest income. Ordinary Least Square (OLS) analysis
was the main analytical tool. In addition to regression, an exploratory data analysis was
also conducted.

1.5 Significance of the study

The findings of this study would assist the decision makers of commercial banks in
making decisions regarding the mobilization of available funds towards microfinance
services.

Moreover, this study will assist the private commercial banks in the decision of
entering the microfinance market and understand the environment of microfinance
market in Sri Lanka.

In addition to that, this study will help the policy makers of the government in
deciding to make the commercial banks involved in microfinance activities.

1.6 Limitations of the Study

Microfinance market comprises with many types of institutions such as MFIs,
Government and nongovernment organizations and programs, specialized banks,
development banks and commercial banks. However, this study focuses only on
commercial banks.
Microfinance contains a range of services such as micro credit, micro savings,
micro insurance, and micro leasing. One service might be profitable for commercial
banks while other generating losses or less profit. These variations had not taken into
consideration in this study.

3
 Differences of microfinance models, interest rates, and time period of lending
have not been taken into consideration in this study even though those factors can have a
substantial effect on the profitability.
Moreover, this study had taken only five banks during the period of four years
into consideration.

1.7 Summary and Organization of Chapters

Governments and policymakers consider microfinance as an effective development tool

that empowers SMEs. During the past decade, commercial banks have entered into the
microfinance market with different intentions, such as corporate social responsibility,
profit motive, fulfillment of legal requirements, etc. Even if a commercial bank enters the
microfinance market for fulfilling mandatory requirement by the government or as a
corporate social responsibility movement, commercial banks have to consider the
profitability of microfinance services because it affects the long-term viability of
microfinance programs they start with any intention. Despite the fact that an increasing
number of banks have entered into the market, only a limited number of studies have
been undertaken to assess the profitability of microfinance services offered by
commercial banks. Therefore, this study attempts to measure whether microfinance
services offered by commercial banks are profitable.

The rest of this dissertation organized into four chapters. Chapter two comprises
with the literature review. It discusses different viewpoints regarding the effect of
microfinance services on the profitability of commercial banks. It provides the theoretical
background for the study. Chapter three illustrates the methodology used in the study. It
describes the analytical tools and methods used in addition to data collection techniques.
Moreover, it describes the research design in relation to the conceptual framework.
Chapter four comprised with the results of regression and the exploratory data analysis of
the study and the interpretation of those results. It provides the basis for the conclusion of
the study. Chapter five present a broad discussion of the whole study including key
findings and a conclusion to the research with the implications of the study. It comprises
with the outcomes of the study.

4
 CHAPTER 2

2 LITERATURE REVIEW

2.1 Introduction

Microfinance has gained much emphasis in as a development tool since it empowers the
SMEs and focus on low-income people. Not only have the MFIs, commercial banks also
moved towards microfinance into an increased number during the past decade. They also
have been able to serve a considerable share in the microfinance market. In the decision
of mobilizing their funds towards microfinance, profitability factor probably would have
done much effect since it affects their retention in the market. This chapter includes a
broad discussion of the literature related to the microfinance and the commercial banks’
performance in the microfinance market in Sri Lanka.

The study has divided this chapter into five sections in the discussion. Section 2.1
includes the introduction to the chapter while a brief explanation of microfinance is
included in section 2.2 based on the different definitions given by different authors and
institutions. Section 2.3 includes a discussion regarding the competition in the
microfinance market. In the section 2.4, the study has provided the literature regarding
the microfinance movements of commercial banks and a discussion in relation to effect
of microfinance to the profitability of commercial banks. Finally, summary for the
chapter is included in the section 2.5.

2.2 Microfinance

Microfinance refers to “The provision of a broad range of financial services that includes
services such as deposits, loans, payment services and insurance to poor and low income
households and their micro enterprises” (ADB,2002). In some instances, it has
recognized that these services are specially provided to the women (Microfinance
Information Exchange, 2010). In practice these ranges of small-scale financial services
target the SMEs who has limited access to such services from banks and other financial
institutions due to stringent, collateral, and other conditions imposed by the banks
(Microfinance practitioners association 2009), (Panday, 2009). However, it has been

5
sometimes defined narrowly to include only the micro loans (i.e. Loans for consumption,
income subsistence and micro-enterprise start-up and expansion) and other services from
providers that identify themselves as MFIs (Microfinance gateway, 2013).

Microfinance appears as a multi-purpose tool used by different institutions. The

government uses microfinance as a policy tool for poverty alleviation and as an
intervention tool in war torn areas. Concurrently, it is used as a not for profit and image
building activity as well as a commercial activity by banks and other financial institutions
(Gant, et al 2002).

2.3 Competition in Microfinance market in Sri Lanka

Even though literature has not given much emphasis to the competition in the
microfinance market, it evidenced that the number of diverse types of microfinance
service providers entering into the market has increased over the past decade. Since the
microfinance market comprised with blend of government institutions, non-government
organizations, cooperative societies, and commercial banks etc. a competition would
essentially be emerged to attract clients.

As identified by Atapattu (2009), providers who are able to mobilize more funds
towards microcredit could be able to have more advantage in the microfinance market,
since there is a higher demand for microcredit when compared to other microfinance
services.

While discussing post-tsunami microfinance in Sri Lanka, Srinivasan (2008) had

stated that, the competition has risen in the microfinance market in the southern province
in the post tsunami period. Further, he has said that the expansion of services to new
areas has caused severe competition in the microfinance market in Sri Lanka.

Commercial banks act in a different way compared to the other financial

institutions in the microfinance market. With the existing resources and technology, they
have introduced new microfinance models and practices to offer their services (Young,
2004). Some of them use the model of internal unit, which operates within the existing
bank structure or as a financial subsidiary or a joint venture. Commercial banks also

6
perform their microfinance activities in the form of a non-financial company that
provides loan origination and credit administration services. Most common strategic
alliance forms are financing portfolios of specialized microfinance institutions and
providing operational support in terms of disbursements and collections through bank
branches.

These strategies have assisted them perform their microfinance activities more
widely and successfully when compared to other financial institutions in the market.
According to Srinivasan (2008), the state owned banks do not have a much competition
in the microfinance market in Sri Lanka.

2.4 Microfinance and Profitability of Commercial Banks

High competition in the sector has forced the banks to diversify their products and
services into new markets. As a result, many of the commercial banks have looked for the
opportunities in the microfinance market. Literature has identified this trend of
commercial banks as a downscaling of their services. Entering microfinance has enabled
the commercial banks to diversify their loan portfolio and client base. Their aim is to
increase the number of small-scale borrowers as much as possible (Delfiner & Peron,
2007). Through microfinance, some banks seek a new public image, and others seek
profits. Commercial banks’ entry into this new market has been always encouraged by
the central bank since it complies with the poverty alleviation policy of the government.
Therefore, the central bank provides rediscount rates and the technical assistance required
by the commercial banks in the microfinance market (Baydas, et al 1997).

Groen (1998) has argued that, a great deal of microfinance undertaken by

commercial banks was because of government mandates to lend to this sector rather than
for business reasons. Further, according to her view majority of commercial banks think
of microfinance programs as risky, unprofitable, and as an activity not fitting with their
core business. However, some of the commercial banks, who are with positive attitudes
towards microfinance, have undertaken comprehensive analysis of the market, and

7
designed profitable models and structures of microfinance, and have been able to gain
economies of scale (Groen, 1998).

Even if a bank enters the microfinance market for reasons associated with
corporate social responsibility or other not for profit reasons, its contribution to the
bank’s profitability determines the long-term viability of the microfinance program
(Curran,et al 2005).

However, the case studies conducted by GTZ provide evidences to prove that in
Sri Lanka, the commercial banks do have an interest in microfinance market and have the
ability to manage their service portfolios profitably. While the two state banks fulfilling
the poverty alleviation goal of the government, Hatton National Bank is the first private
commercial bank that entered the microfinance market with a viable microfinance
scheme with profits. Followers also try to introduce innovative schemes to meet the
challenges of the market and attain growth and profitability goals (Gant,et al 2002).

Commercial banks whose intention is to earn profits, consider micro credit as the
core microfinance activity since micro lending is the product with the highest demand in
the microfinance market (Segal, 2008). When considering micro savings, state-owned
banks (Bank of Ceylon and People’s Bank) are the most popular among low-income
people as those two banks hold 75 percent of household savings. Micro insurance covers
the areas of life, property, mortgage, loss of income and disability insurance. Some
arguments say that the commercial banks do not prefer to engage in micro insurance
services since those services do not have proven to be profitable for them (GTZ, 2009).

Even though the commercial banks struggle with management accounting issues
in measuring the costs of their microfinance services, they try to increase the number of
clients and make profits since they are well equipped to serve an increasing number of
clients compared to other financial institutions in the market.

Through her studies Groen(1998) has introduced several key success factors for
commercial banks entering microfinance market. She has suggested creating a small-
specialized bank or a separate microfinance unit within the commercial bank to conduct

8
the microfinance activities separately. In contrast to her suggestions include, treat micro
savings equally important as micro lending, charge the interest rates that sufficient to
cover all the costs incurred in the provision of services, maintain a sound management
information system and better portfolio management practices, provide staff with
training, and assign a specialist who will ensure the success of the microfinance program.

2.5 Summary

Limited discussions could find in the literature related to microfinance movements of

commercial banks in Sri Lanka. Micro-finance has defined in various ways by different
authors. Initially, it can define as the provision of financial services to SMEs who have
lacked access to banks in formal collateral conditions. Even though there are different
ideas regarding the entrance of commercial banks into microfinance market, many of the
authors have accepted that there is an emerging trend of entering commercial banks into
the microfinance market. The microfinance movements of commercial banks may have
supported by various types of reasons other than the profit motive. However, the
profitability factor is a considerable in the growth and sustainability of commercial
banks. Profitability is a distinctive factor in attracting private commercial banks to the
microfinance market. As commercial banks play a key role in the financial system of the
country, their involvement in the microfinance market is also important for the
development of the country as well. Therefore, examining the profitability microfinance
relationship is essential for the decision makers of the commercial banks. Anyway, very
few literatures could find in this regard in Sri Lankan context.

9
 CHAPTER 3

3 METHODOLOGY

3.1 Introduction

As more commercial banks inspired by microfinance as discussed in the literature review,

the lessons learnt by some of the more experienced players who have already entered the
market become useful in the decision-making process of new comers. Entrance of
commercial banks to the microfinance market dated back to few decades in Sri Lanka.
Therefore, measuring their performance with regard to the microfinance market, using an
appropriate method would assist them to conclude the relationship between profitability
and the provision of microfinance services. Therefore, this study attempted to investigate
the relationship between the provision of microfinance services and the profitability of
commercial banks during the past decade.

This chapter comprise with the discussion of the way the research has conducted
in attaining the research objective. In that case, this chapter has organized into four
sections. Introduction to the chapter is included in the section 3.1. Section 3.2 has
explained the research design based on the conceptual framework. In section 3.3, sample
of the study and the data analysis methods described. Chapter summary is included in the
section 3.4.

3.2 Research Design

As displayed in the figure 3.1, this study attempts to measure the impact of microfinance
on the profitability of commercial banks. Based on the hypothesis that there is a
significant impact on profitability of commercial banks by providing of microfinance
services, secondary data obtained to measure the variables.

10
 Micro Finance
Profitability of
Volume of Micro
Commercial Banks
credit
Loans & Advances  PBT

Figure3. 1Conceptual framework

Commercial banks consider micro credit as the core microfinance activity and
concentrate on the provision of micro lending majorly compared to other microfinance
services (Segal, 2008). Based on this practice of the commercial banks, only the micro
lending portfolios took into account in this study besides the other microfinance services.
Therefore, the volume of micro lending represents the amount of microfinance services
each bank provides.

Erina and Lace (2013) have identified, profitability and efficiency of commercial
banks include factors of three categories, internal indicators (i.e. Bank size, operating
efficiency, credit risk, portfolio composition and asset management), external indicators
such as macro-economic changes (e.g. Growth of annual gross domestic product, annual
inflation), and Specific indicators, i.e. ROA and ROE (Erina & Lace, 2013). Measures of
return on average total assets (ROA) and the return on total equity (ROE) are widely used
indicators to assess the performance of commercial banks (Delfiner & Peron, 2007).

In the previous studies, researchers most commonly have used the profits to asset
ratio (i.e. ROA) and profit to equity ratio (i.e. ROE) as profitability indicators (Erina &
Lace, 2013). In a similar case study conducted by GTZ, has used CAMEL indexes in
addition to these profitability ratios. In the CAMEL analysis, they assess five key aspects
of the operations of banks, i.e. Capital, Assets, Management, Earnings, and Liquidity.
CAMEL is widely used in measuring the performance of banks by the researchers.

11
 However, when considering in the microfinance aspect, it deals with small-scale
financial services. Therefore, its representation of the total average assets and the equity
is obviously small. Considering all the factors and the literature, this study identified PBT
as the main profitability indicator of the selected commercial banks in measuring the
impact of microfinance. Eventually, microfinance has represented by the amount of
micro lending for the purpose of the study.

3.3 Sample and Data Analysis

Five commercial banks engaged in the provision of microfinance services in Sri Lanka
were selected using random sampling techniques. This included two state banks and three
private commercial banks. The study covers the period between year 2009 and 2012.
Secondary data, such as amount of micro lending and profitability measure PBT was
obtained from the published annual reports of the selected banks during the period under
concerned. OLS Regression was the main analytical tool for assessing the impact of
microfinance on profitability. Regression equation been used in the study was,

Y=  +  1(ML) + 2(LA) + .

ML denotes amount of micro lending and LA denotes Loans & Advances.

In addition to regression, an exploratory data analysis also was conducted to

analyze the relationship of micro lending with net interest income and PBT. Results of
the exploratory analysis are presented in the graphical method.

3.4 Summary

Commercial banks have increasingly entered into the microfinance market during the
past decade. Both state and private banks have turned towards microfinance with
different intentions such as government policy implementation, image-building activity,
and with commercial purposes. Profitability of the microfinance programs will affect the
retention and the growth of the commercial banks in microfinance market. Therefore, this
study focuses on determining the impact of microfinance to the profitability of
commercial banks in Sri Lanka.

12
 This chapter comprised with a comprehensive discussion of the way the study has
been designed, conducted, and has arrived into the conclusion. The conceptual
framework had presented with the purpose of representing the objective of the study and
the variables measured. The sample of the study comprises five commercial banks and
obtained the data from published annual reports over the period of four years. In attaining
the research objective, microfinance has taken into account in terms of the amount of
micro lending. Moreover, the study used PBT as the profitability indicator. The
relationship between the profitability and microfinance, measured using the OLS
analysis.

13
 CHAPTER 4

4 DATA ANLYSIS AND DISCUSSION

4.1 Introduction

This chapter has comprised with the results of the study by analyzing the data obtained
from the sample, to measure the relationship between microfinance and profitability of
commercial banks. In this study, the relationship between micro lending and the PBT was
analyzed using linear regression.

This chapter has divided into four sections. Section 4.1 consists with a brief
introduction to the chapter and the section 4.2 comprises with the regression results
obtained from OLS. All the significant information that affect the research outcome have
presented in 4.2. An exploratory analysis of the variables is included in section 4.3. The
final section, 4.4 summarizes the discussion of the data analysis chapter.

4.2 Exploratory Data Analysis

Figure 4.1 presents the relationship between micro lending and net interest income. Since
the sample of the study represents the microfinance movements of commercial banks in
Sri Lanka, their total micro lending, and interest income figures have taken into
consideration in presenting the market trends. Even though it would be more effective to
compare the interest income from micro lending with net interest income, there are
limitations in the accessibility to such data. Therefore, the study observed the pattern of
the movement of micro lending and net interest income of commercial banks during the
period under concerned. The graph presented in the figure 4.1, it is obvious that the
amount of micro lending and interest income have a positive relationship while the micro
lending amount increased, net interest income has also increased. There is rapid increase
in both micro lending and net interest income during the period of 2010 to 2011.

14
 250,000.00

200,000.00

150,000.00
NII
100,000.00 ML

50,000.00

-
2009 2010 2011 2012

Figure4. 1 Net Interest Income & Micro Lending

Figure 4.2 indicate positive relationship of micro lending and PBT of commercial banks.
The graph has clearly indicated that, with the increase in micro lending PBT also has
increased during the period. During the period of 2010 to 2011, there is a rapid increase
in the micro lending and PBT.

200,000.00
180,000.00
160,000.00
140,000.00
120,000.00
100,000.00 PBT
80,000.00 ML
60,000.00
40,000.00
20,000.00
-
2009 2010 2011 2012

Figure4. 2 PBT & Micro Lending

15
4.3 Descriptive Statistics of the variables

Table 4.2 presents the descriptive statistics of the variables used in the regression with
minimum, maximum, mean and SD values for the period of 2009-2012 of the selected
banks. Within the period under concern, commercial banks have provided average
amount of 12, 642Mn LKR micro lending ranging from the minimum amount of 19Mn
LKR to the highest amount of 95,403Mn LKR. The Seylan bank which is a private
commercial bank, has provided the minimum amount of micro loans in 2012, while the
maximum lending has done by BOC in the same year. The largest Loan portfolio was
also belonged to BOC in 2012. At the same time, BOC has been able to earn the
maximum amount of PBT (i.e.23, 009Mn LKR).

Table 4. 1 Descriptive Statistics

Descriptive Statistics
Mean Std. Deviation Minimum Maximum
ML (Micro Loans) 12642.42 27866.64 19.4 95403
LA (Loans and Advances) 322538.59 197680.64 80288 691899
PBT 9458.42 5961.93 892.57 23009
N=20

4.4 Impact of microfinance on profitability of commercial banks

In accomplishing the purpose of measuring the impact of microfinance to the profitability

of commercial banks, the study used regression as the main analytical tool. This section
discusses the results obtained from the OLS analysis.

Regression results revealed that the micro lending and loans & advances of
commercial banks were highly correlated with of their PBT. Further, the results indicated
that independent variables of the model, ML, and LA explained 88 percent of variance in
PBT (R2 = .887, F = (2, 17) = 66.907, p < .001, DW= 2.12). Durbin-Watson value was
almost closer to two, which implied that the model was free from serial correlation.
Finally, based on the OLS analysis results, the study concluded that there is a significant
positive statistical relationship among the variables used in the research model.

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As indicated in Table 4.1, it was found that, independent variables significantly predicted
aggressive tendencies of PBT while ML ( =.31, p=.005) and LA ( =.73, p<.000).

Table 4. 2 Regression Results

Coefficients(a)
Model  Std. Error t Sig.
(Constant) 955.155 1.514 0.148
ML (Micro Loans) 0.310 0.021 3.206 0.005
LA (Loans & Advances) 0.737 0.003 7.620 0.000
a Dependent Variable: PBT

4.5 Summary

As discussed in the methodology, the study used data obtained from published annual
reports of five commercial banks over the period of 2009-2012 for measuring the impact
of microfinance to the profitability of commercial banks. To accomplish this research
objective, the study analyzed the data using exploratory data analysis and OLS analysis.

The results revealed that, there is a statistically significant positive relationship

among micro lending, total loans & advances and PBT during the period under
concerned. In other words during the period of 2009-2012 PBT has increased with the
increase of micro lending and loans & advances.

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 CHAPTER 5

5 CONCLUSION AND IMPLICATONS

5.1 Introduction

Microfinance movements in Sri Lanka dated back to 1911 and the first microfinance
service provider was the Thrift and Credit Cooperate societies, which are still active in
the microfinance market. Since then, a number of government and non-government
organizations, facilitate the small-scale entrepreneurs and poor people with small-scale
financial services who have lacked access to formal banking services under the collateral
and strict legal conditions imposed in the formal banking structures.

The government and policy makers have identified micro finance as an effective
development tool that helps in the poverty reduction movement of the country. Therefore,
the central bank and the government encourage and assist commercial banks in engaging
microfinance activities. HNB is the first mover to the microfinance market from private
commercial banks. Since then, a number of private commercial banks have entered the
microfinance market with different motives such as image building, complying with legal
requirements and as a commercial activity.

This chapter has been divided into several sections. Section 5.1 included a brief
introduction to the chapter, and section 5.2 presents the key findings of the study. In the
section 5.3 conclusions of the whole research have discussed in a broad sense. There
included a comprehensive discussion regarding microfinance and commercial banks’
movements in microfinance market. Section 5.4 has represented the implications and
recommendations of the study while section 5.5 has summarized the discussion of the
whole chapter.

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5.2 Key findings of the study

First, there is a statistically significant positive relationship between total loans &
advances and PBT of commercial banks. The bank with the highest loan portfolio and
highest micro lending during the period has been able to earn the highest PBT.

Second, there is a strong positive statistical relationship among micro loans and
PBT of commercial banks. In other words, PBT of commercial banks increases with the
increase of micro lending by them. This is the most important finding of the data analysis
that confirms the research hypothesis.

Third, micro lending and net interest income have a positive relationship. Where
the micro lending increased net interest income has also increased.

However, finally the study found that the state owned banks have performed more
successfully in the microfinance market than private commercial banks. State owned
banks have larger microfinance loan portfolio compared to private commercial banks and
they have earned more profits during the period.

5.3 Conclusion

There is a rapid increase in micro lending by the commercial banks during the period of
2009-2012. Microfinance programs implemented during this period have mainly focused
on North, East and Southern provinces of the country. The main reason behind this could
be the development programs implemented in the north and eastern areas of the country
after the civil war. With the end of the civil war, the demand for microfinance services
was increased. The central bank has also imposed a mandatory requirement for
commercial banks to provide microfinance services. There are a number of organizations,
including the central bank, which assist commercial banks with donor funded micro loan
schemes. Not only the donor funded programs, commercial banks have now moved to
mobilize their own funds and resources to microfinance market and earn profits.

Moreover, according to the analysis of net interest income and the micro lending,
there is a rapid growth in the amount of micro lending by commercial banks over the
period of 2009 to 2012 and that there is a positive impact from micro lending to the net

19
interest income of commercial banks. Finally, the study can conclude that, there is
significant effect form microfinance to the profitability of commercial banks.

5.4 Implications

Banks with higher micro lending in their loan portfolio has been able to earn higher PBT.
Therefore, this finding would assist the decision makers of the commercial banks in their
decision-making processes in the decisions of mobilizing available funds toward
microfinance market. There are a number of advantages for commercial banks in
providing microfinance services such as increasing customer base, decreasing the credit
risk, etc. Commercial banks should design more suitable and profitable model when
entering the microfinance market. Entrance of commercial banks to the microfinance
market would lead the market to a rapid growth, while empowering the poor and
contributing to the development of the country.

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