Abstract
Financial system stability is one of the key fundamentals upon which economic growth is based. Most developing countries’ financial system is dominated by the banking sector. Commercial banks constitute the anchor of the growth of other sectors by providing them access to credit facilities in the form of loans consequently, the soundness of the banking industry is an essential consideration for financial system stability. Though there were many research studies published in the banking sector for enhancing customer loyalty, there is limited consideration to identify reasons for non-performing loans in the banking sector in Sri Lanka. Thus this study was conducted to assess factors affecting loan defaults in addressing the aforementioned gap. The quantitative research approach was adopted for the study. A survey was conducted with professionals engaged in two state-owned commercial banks using a self-administrative questionnaire. A convenient sampling procedure was used to obtain 164 responses from customers. Correlation and multiple regressions were used to investigate the relationship between dependent and independent variables. The finding of the study shows that economic factors, and institutional factors to the causes of loan default. The research proved that institutional factors and economic factors impacted loan defaults. The findings of the study suggest to the bank managers, loan officers, recovery officers, and other staff members to pay attention to credit terms, monitoring, inflation rates, and the income of the customers when they grant loans for new customers. The findings of this study will aid the management to improve their management of non-performing loans, encourage bank managers to participate more in policy formulation at the micro and macro levels as far as bad debt management is concerned, and also to diversify bank's investment portfolios.