Rise of Digital Banking and Its Impact on Loan Default of Islamic Financial Institutions in Sri Lanka

Abstract

Received: 22/05/2025 Revised: 15/09/2025 The rise of digital banking has revolutionized the operations of Islamic Financial Accepted: 20/11/2025 Institutions (IFIs) in Sri Lanka, providing convenience and efficiency while introducing new Published: 15/06/2026 challenges in credit risk management. This study focuses on whether the impact of digital banking on Sri Lankan IFIs improves loan repayment or contributes to higher default rates. This study answers the question: How does digital banking affect loan defaults in Islamic financial institutions in Sri Lanka? This study aims to examine the influence of digital banking on loan repayment behavior, particularly within Shariah-compliant financial institutions. It assesses how digital banking services such as automated loan processing, AI-driven loan evaluation and mobile banking services impact customer satisfaction and loan default rates. A quantitative research methodology was employed using survey data collected from customers and banking professionals of three major IFIs: Amana Bank, HNB-An Naja and LOLC Al-Fala. The study used the E-SERVQUAL model to measure customer perception of service quality, along with correlation and regression analyzes to assess the relationship between digital banking adoption and loan default. Findings indicate that while digital banking improves accessibility and operational efficiency, factors such as ease of use, system availability and customer responsiveness significantly influence loan repayment behavior. These findings have important implications for IFIs, policy makers and regulators as they highlight the need for strategic improvements in digital banking structures to ensure financial stability. Strengthening customer education, improving cyber security and improving service responsiveness can mitigate loan defaults while promoting digital financial inclusion in the Islamic banking sector.