THE IMPACT OF LIQUIDITY MANAGEMENT ON FINANCIAL PERFORMANCE OF FIVE NIGERIAN COMMERCIAL BANKS (2005 – 2015)
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THE IMPACT OF LIQUIDITY MANAGEMENT ON
FINANCIAL PERFORMANCE OF FIVE NIGERIAN COMMERCIAL BANKS (2005 – 2015)
ABSTRACT
The study
examined the impact of liquidity management on the financial performance of
commercial banks in Nigeria. The study adopts the use of primary data from 5
commercial banks still operating within (2005-2015), which are First Bank,
Ecobank, Union Bank, Wema Bank, Fidelity Bank.
The study
employed the survey design and the purposive sampling technique to select 450
staff across management, senior and junior level. A well-constructed
questionnaire, which was adjudged valid and reliable, was used for collection
of data from the respondents.
The data
obtained through the administration of the questionnaires was analyzed using
the Pearson correlation analysis.
The results
showed that there is positive and significant relationship between liquidity
ration and financial performance (r=0.772; p<0.05); a positive and
significant relationship exists between cash reserve ratio and financial
performance (r=.896; p<0.05); a positive and significant relationship exists
between loan to deposit ration and financial performance (r=0.772; p<0.05).
The study
concludes that there is a significant relationship between liquidity ratio,
cash reserve ration and loan to deposit and financial performance in commercial
bank of Nigeria.
The study
suggested that commercial banks should ensure that expenditure are properly
managed in a manner that it will raise the company’s liquidity performance
capacity; commercial banks should direct its expenditure towards the productive
departments as it would reduce the cost of doubt and risk; there is need for
efficient management of liquidity ratio, cash reserve ratio and loan to deposit
in such a way to stimulate the company to grow.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Nigeria,
often referred to as the ‘Giant of Africa’ became an independent country in
1960. The government of the federation had a constant alternation between the
military rulers and the democratically – elected rulers, until it stabilized in
1999 with Chief Olusegun Obasanjo becoming the President. Nigeria was a
colonized country by the British before she gained her independence and it was
during her pre – independence period that she was given the name Nigeria. The
name, which was coined from the River Niger, was given by Flora Shaw.
Before the
introduction of currency of exchange, the country was operating a system of
trade called the barter system. This system involved the exchange of goods for
goods or services for services. This system is an ancient system that was used
by our fore fathers in their exchange with the British masters coming from the
South and the Arabs coming from the North. Due to the diverse trade, it brought
about diverse currencies, which can be grouped into two; local/indigenous currency
(e.g, iron, animals, salt, feathers, beads, etc), and imported/non indigenous
currency (e.g, cowries, manilas, copper, iron bar, gin and tobacco. (Mint,
2016)
These means
of exchange had to be replaced because some of them were limited to a particular
area; some were very cumbersome and lacked the distinctive quality of what the
modern day exchange means. These limitations brought about the introduction of
a uniform and acceptable means of exchange, which were the coin and paper
money.
The Nigerian economy has various
factors/elements that are vital for the survival of the economy. Financial
institutions are seen as one of the elements needed for this survival. They
have contributed greatly to the growth of the economy and have helped in
providing effective ways by which the resources of the economy have been
mobilized and deployed for national development. Commercial Banks are part of
the financial institutions.
These banks
began to exist in the year 1892 with the first one being African Banking Corporation
Ledger Depositor and Co. and was later taken over in 1984 by the bank of the
British West African, which later became First Bank of Nigeria PLC and Standard
Bank. (Skylar, 2015) After the Second World War, economic activities in the
country rose and this brought about the incorporation of more banks. Between
1905 and 1975, about eighteen banks had been established but by 1975, most of
them had gone into liquidation or had closed down. It was due to the various
shut down that the Central Bank developed a policy that mandated all banks to
increase their capital base from N2 million to N25 billion naira (Agbada and
Osuji, 2013)
Banks make
their own revenue by lending money at a rate higher than the cost of the money
that they lend to customers, by remitting the loans that have been imposed on
loans and debt securities. They are seen as the backbone of the economy as they
facilitate saving and borrowing. Their major function is that of deposit
mobilization and credit extension. Due to its varying functions, it is exposed
to different problems, one of such is liquidity management. (Johnson, 2017)
Liquidity is
said to be the bank’s ability to meet its cash, cheque, and other obligations
as well as its loan demand. The liquidity needs of a bank are usually defined
by the sum of its reserve requirements imposed on banks by a monetary authority
(Central Bank Nigeria, 2012). Liquidity management not only affects the
performance of a bank but also its reputation (Jenkinson, 2008). A bank will
lose the confidence of its customers if funds are not provided to them when
they are needed. The bank’s goodwill may become at stake in this situation.
Liquidity
management has become a serious challenge for the modern banks (Comptroller of
the Currency, 2001). A bank having good asset quality, strong earnings and
sufficient capital may fail if it is not maintaining adequate liquidity (Crowe,
2009).
During the
last crisis which occurred in the ‘80s, many banks ran out of liquidity, some
had raise funds at a discount in order to meet with the high of demand for
urgent cash. Liquidity markets were frozen. Many financial institutions had to
review their corporate governance policies in order to accommodate liquidity
risk exposures. (Edem, 2017)
Bhattacharyya
and Sahoo (2011), argued that liquidity management by Central banks refers to
the framework, set of policies and instruments, and the rules that the monetary
authority follow in managing systemic liquidity, consistent with the goals of
monetary policy.
According to
Central Bank’s Monetary, Credit, Foreign Trade and Exchange Policy circular for
the fiscal year 2016/2017, it stated that commercial banks as well as merchant
banks are expected to maintain a liquidity ratio of 30, 20, and 10 per cent
which is subject to review from time to time. The maintenance of this ratio
will aid effective liquidity management which is an important factor that has helped
maintain bank profits and helped keep the banking institution and the financial
system from insolvency. The strategic management for banks has helped at
keeping banks solvent and liquid in order for them to earn good profits and
remain financially stable (Agbada and Osuji, 2013). In order to keep the
confidence the public has in the financial system and to increase the survival
of the financial system of the country, banks have been required to maintain
adequate and sufficient amount of cash and near cash assets in order to meet
the withdrawal obligations of the public.
1.2 STATEMENT OF PROBLEM
Management
of liquidity has been an important agenda for every bank for the past few years
in Nigeria. Bassey, Tobi, and Ekwere (2016), stated that for the successful
survival of banks, policies should be put in place to guard the effective and
efficient management of liquidity which enables them to satisfy their financial
obligations to customers, build public confidence to maximize the profit for
shareholders.
Failure in
liquidity management has a negative effect on bank operation and has a long
term effect on the economy as a whole. Liquidity management is seen as the
major element in measuring the going concern for banks and this is the reason
they have come up with the idea to develop policies to improve the liquidity
position, yet the problem is unsolved. Edem (2017) states that, the attempts by
bank managers to increase return tend to have negative impact on liquidity
which might be dangerous to the banks as this can lead to loss of bank’s
patronage, goodwill, deterioration of bank’s credit standings and might lead to
forced liquidation of bank’s assets on one hand, and maintaining excess
liquidity to satisfy customers’ demands might affect the returns on the other
hand.
Sensarma and
Jayadev (2009), stated their findings that banks’ management capabilities as
regards liquidity has been improving as well as banks’ returns on stocks. They
stated that the banks’ stocks have been sensitive to the management capability
of banks, which means that there is a positive relationship between the banks’
liquid assets and its return on equity.
These
statements from both parties contrast each other which gives way for the
purpose of this research to empirically investigate the impact of liquidity
management on the performance of banks and ascertain which party’s statement is
more realistic using Nigeria as a case study.
1.1 Objectives of the Study
The broad
objective of the study is to examine the impact of liquidity management on the
financial performance of commercial banks in Nigeria. The specific objectives
of the study are:
To assess the impact of liquidity ratio on
the financial performance of commercial banks in Nigeria.
To investigate the impact of cash reserve
ratio on the financial performance of commercial banks in Nigeria.
To explore the impact of loan-to-deposit
ratio on the financial performance of commercial banks in Nigeria.
1.2 Research Questions
The study
attempts to provide answers to the following research questions:
To what extent has liquidity ratio affected
the financial performance of commercial banks in Nigeria?
To what extent has cash reserve ratio
affected the financial performance of commercial banks in Nigeria?
To what extent has loan to deposit ratio
affected the financial performance of commercial banks in Nigeria?
1.3 Research Hypotheses
Based on the
research objectives, the following hypotheses are developed to guide the study.
The hypotheses are stated in their null forms.
H01: Liquidity ratio has no significant
impact on the financial performance of commercial banks in Nigeria.
H02: Cash reserve ratio has no significant
impact on the financial performance of commercial banks in Nigeria.
H03: Loan to deposit ratio has no
significant impact on the financial performance of commercial banks in Nigeria.
1.6
SIGNIFICANCE OF THE STUDY
The
significance of this study is directed at getting relevant and sufficient
information that would help in solving the liquidity problem being faced in the
country. The researcher believes that the information derived will be of great
benefit to the following group of people:
The
government, this study will help the government in setting appropriate
liquidity ratio and cash ratio that will not be harmful to the operation and
survival of the commercial banks.
Students/Academic
area, this study will prove to be significant in this area as it will serve for
future references when carrying out further research.
Central Bank
of Nigeria, this study will help this authority to evaluate how effective
liquidity management and credit policy guidelines will affect profitability.
Investors,
this study will help this group of people to decide if they would put their
resources into a particular economy and if they would get a good return for
their resources.
Ministry of
Finance, this study will help this regulating authority in ensuring that the
policies being set by the Central Bank are being followed accordingly.
1.7 SCOPE OF THE STUDY
This study
will be making use of five commercial banks, which are, First Bank, Ecobank,
Union Bank, Wema Bank, Fidelity Bank. The information needed to carry out this
study will be derived from their financial statements for the period of 2005 –
2015 (10 years).
These banks
have been chosen for this study due to some characteristics peculiar to them.
The banks, First Bank, Union Bank, Ecobank, Wema Bank, and Fidelity Bank have
been chosen for the singular reason that they have been in existence for a long
period of time and they were not part of the banks that were merged during the
2011 consolidation by the Central Bank of Nigeria (CBN).
1.8
DEFINITION OF TERMS
LIQUIDITY:
this is a term used to describe a firm’s ability to convert its assets to cash
to pay up its liabilities/obligations.
PERFORMANCE:
DEPOSIT
MONEY BANKS: this is a financial institution that is licensed by the regulatory
authority to mobilize deposits from the public and channel the funds through
loans and performs other financial services activities.
CASH: this
is referred to as the most liquid asset that a company can hold.
NEAR CASH
ASSETS: these are assets that can be quickly converted to cash. Such assets are
rental income, treasury bills, etc.
MONETARY
POLICIES: this is a macro economic policy that is carried out by the Central
Bank in order to manage the supply of money which in turn affects the interest
rate.
RETURN ON
CAPITAL EMPLOYED: this is a financial ratio that measures a company’s profitability
and the efficiency with which its capital is employed.
DEBT EQUITY:
this is a ratio that is used to determine how much debt a company is using to
finance its assets relative to the amount of value represented in shareholders'
equity.
DEBT RATIO:
this is the ratio of the total long term and short term debt to total assets.
INTEREST COVER: this is used to determine how
easily a company their interest expenses on outstanding debt.
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