IMPACT OF LIQUIDITY MANAGEMENT ON THE FINANCIAL PERFORMANCE OF DEPOSIT MONEY BANKS IN NIGERIA

Introduction

1.1 Background to the Study

The recent crisis in the world economic system has unveiled some inadequacies in the liquidity management of financial institutions. Financial institutions like banks are seen as the backbone of the financial system, providing capital for infrastructure, innovation, employment generation and economic development (Edem, 2017). The fundamental role played by banks in the economy does not only affect the spending by individual consumers but also the general growth of the industry. During the last crisis, many banks ran out of liquidity. Some banks raised funds at a large discount in order to meet up with high pressure of demand for urgent cash. Liquidity markets were equally frozen. Many financial and non-financial institutions had to revise their corporate governance policies to accommodate market and liquidity risk exposures. Equity prices, foreign exchange rates, commodity prices, interest rate and credit spread had negative impact on the performance of banks as their returns on investment and net-worth fell tremendously. A lot of assets were devalued and some banks hardly meet their obligations as and when due or discharge at high cost. This influenced the bank’s capacity to stimulate productive economy evidenced in gradual decline of gross domestic product. This is why liquidity issues have always been a concern of all the nation’s stakeholders, because no sector of the economy can survive without sufficient funds.

The Central Bank of Nigeria, over the years, precisely since 1958, has formulated sound policy to resuscitate the Nigerian financial system for sustainable economic growth. The policy which came in the form of re-capitalization, merger and acquisition and consolidation aimed at strengthening the financial system with little or no emphasis on the efficiency of liquidity management. For instance, the event of 1980s, which characterized the unprecedented level of distress reflected by large volume of non-performing loans, problem and default in meeting depositors and inter-bank obligations called for the innovations in banking industry in 1986 (Okaro & Nwakoby, 2016). This innovation and other banking reforms in Nigeria have not produced desired results in stabilizing the banking industry due to poor implementation or sudden termination of the reforms. Government directive to withdraw deposits of governments and other public sector institutions in 1989 from banks to Central Bank of Nigeria and several historical distresses in the banking sector are examples of liquidity problems facing the banking industry in Nigeria.

However, financial regulators have made conscious efforts to ensure that banks hold more liquid assets than before to help self-insure against potential liquidity problems. For example, Basel II was recently revisited to provide for more capital buffer to hedge bank flimsiness as well as a common measure of operational risk (Ibe, 2013). The purpose of business organizations like bank is to maximize profit. Striking a balance between liquidity and bank return is of utmost importance. Many approaches have been developed over the years to measure bank performance such as the use of accounting ratios like return on investment, return on asset and net interest margin amongst others. The aim of the study is to analyze the impact of liquidity management on banks’ financial performance in Nigeria.

1.2 Statement of Problem

Liquidity management and bank performance are key factors that determine the development, sustainability, survival, growth and performance of a banking industry and the ability to handle the trade-off between liquidity management and performance is a source of concern for bank managers. For instance, banks make loans that cannot be sold quickly at a high price and also issue demand deposits that allows depositors to withdraw at any time. Such a mismatch of liquidity, in which a bank’s liabilities are more liquid than its assets, causes problems for banks when too many depositors attempt to withdraw at once as it affects the liquidity position of banks. Many banks invest in safe and high-yielding illiquidity assets but are tied up in loans. Some banks despite having a lot of assets, the sudden withdrawals and the lack of liquid funds lead to a huge loss as a result of taking out emergent loans. This was identified as the major causes of bank failures and nationalization in 2008 (Barrel & Davis, 2008), alongside with inability to make adequate profit. As the ingredient of measuring the “growing concern” banks for these reasons are developing, various policies to stop runs and strategies to improve the liquidity position are usually neglected in times of favorable business conditions, yet the issue remains unsolved. The attempts by bank managers to increase returns 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, decline in bank’s credit standing and might lead to forced liquidation of bank’s asset on one hand, and maintaining excess liquidity to satisfy customers’ demands might affect the returns on the other hand.

Mistakes in the planning and implementation of liquidity can affect banks operations and might exhibit long-term effect on the economy. Profitability does not translate to liquidity in all cases (Edem, 2017). A bank may be profitable without necessarily being liquid. So liquidity should be managed in order to obtain an optimal level, that is, a level that avoids excess liquidity which may mean lack of business idea by management (Owolabi, Obiakor & Okwu, 2011). At the same time, liquidity level should not fall below minimum requirement as it will lead to the inability of the organization to meet short-term obligations that are due.

1.3 Objectives of the Study

The broad objective of the study is to examine the impact of liquidity management on the financial performance of deposit money banks in Nigeria.

The specific objectives of the study are:

1. To assess the impact of liquidity ratio on the financial performance of deposit money banks in Nigeria.
2. To investigate the impact of cash reserve ratio on the financial performance of deposit money banks in Nigeria.
3. To explore the impact of loan-to-deposit ratio on the financial performance of deposit money banks in Nigeria.

1.4 Research Questions

The study attempts to provide answers to the following research questions:

1. To what extent has liquidity ratio affected the financial performance of deposit money banks in Nigeria?
2. To what extent has cash reserve ratio affected the financial performance of deposit money banks in Nigeria?
3. To what extent has loan to deposit ratio affected the financial performance of deposit money banks in Nigeria?

1.5 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 deposit money banks in Nigeria.

H02: Cash reserve ratio has no significant impact on the financial performance of deposit money banks in Nigeria.

H03: Loan to deposit ratio has no significant impact on the financial performance of deposit money banks in Nigeria.

1.6 Significance of the Study

The study is beneficial to the banking community, monetary authorities and future researchers. The study helps the banking community to determine the appropriate level of liquidity that should be held to ensure the smoothing running of their operations. The study equally informs the banking industry to ascertain the optimal amount of liquidity needed to settle short-term obligations whenever they arise. To the monetary authorities, the study will help the Central Bank of Nigeria to see the need to formulate sound monetary policies with respect to monetary policy ratio; cash reserve ratio and liquidity ratio, in order to enhance the performance of the banking community for sustainable economic development. To future researchers, the study served as a body of reserved knowledge that can be consulted for further investigations on liquidity management and bank performance.

1.7 Scope of the Study

The study examines the impact of liquidity management on the financial performance of deposit money banks in Nigeria. The study concentrated on five banks namely Zenith Bank, United Bank for Africa, Wema Bank, Access Bank and Union Bank. In addition, the study covered a-five year period spanning between 2012 and 2016.

1.8 Definition of Key Terms

Liquid:

According to Business Dictionary, liquidity refers to the extent to which an organization has cash to meet immediate and short-term obligations or assets that can be quickly converted to do this.

Liquidity Management:

This refers to the ability of an organization to convert their assets to cash to meet short-term obligations.

Financial Performance:

This refers to the ability of an organization to achieve its desired objectives. The common objectives of an organization are to maximize profit and wealth of shareholders. Certain accounting ratios such as return on investment, return on shareholder’s fund, return on equity, return on asset and earnings per share are usually used to measure financial performance of organizations.

Bank:

This refers to an institution that accepts deposits from customers, provides loans to customers/clients and acts in compliance with the directives given by the Central Bank of Nigeria.