CASH AND CREDIT MANAGEMENT AS A PANACEA FOR ILLIQUIDITY IN COMMERCIAL BANKS IN NIGERIA

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ADEYEMI OLUWAGBEMISOLA ADEKIITAN

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  • Name: CASH AND CREDIT MANAGEMENT AS A PANACEA FOR ILLIQUIDITY IN COMMERCIAL BANKS IN NIGERIA
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ABSTRACT

This study examined cash and credit management and commercial banks’ liquidity in Nigeria. The major aims of the study were to find empirical evidence of the degree to which effective cash and credit management affects the liquidity performance in commercial banks and how commercial banks can prevent illiquidity by engaging in these practices. Considering the nature of the survey, quantitative methods of research were applied. In attempt to achieve the objectives of the study, several findings were made through the analysis of the financial statement of various commercial banks used as samples over a period of seven years. The data obtained from Secondary sources were analyzed through with the use of panel data regression and correlation co-efficient. A few hypothesis were formulated and were statistically tested through panel regression model. Findings from the testing of this hypothesis indicate that there is significant relationship between cash and credit management and illiquidity. That means liquidity in commercial banks is significantly influenced by credit and cash management. The study concluded that for the success of operations and survival, commercial banks should not compromise efficient and effective cash and credit management and that both illiquidity and excess liquidity are “financial diseases”. Also, that cash and credit management are high important in order to avoid insolvency or illiquidity. Finally the study recommends that banks should not neglect their responsibility of cash management and focus mainly on credit management.

 

TABLE OF CONTENTS

TITLE PAGE……………………………………………………………………………………. I
CERTIFICATION………………………………………………………………………………II
DECLARATION …………………………………………………….……………………….. III
DEDICATION ………………………………………………………………………………… IV
ACKNOWLEDGEMENT………………………………………………………………………V
ABSTRACT…………………………………………………………………………………….VI
TABLE OF CONTENTS………………………………………………………………………VII
LIST OF FIGURES…..…………………………………………………………………………XI
CHAPTER ONE: INTRODUCTION…………………………………………………………..1
1.1 Background information………………………………………………………………………1
1.2 Statement of the problem………………………………………………………………………3
1.3 Objectives of the study………………………………………………………………………..4
1.4 Research questions……………………………………………………………………………4
1.5 Research hypothesis……………………………………………………………………………5
1.6 Significance of the study………………………………………………………………………5
1.7 Scope of the study……………………………………………………………………………..6
1.8 Limitation of the study………………………………………………………………………..6
1.9 Organization of the study……………………………………………………………………..7
1.10 Definition of terms……………………………………………………………………………7
CHAPTER TWO: LITERATURE REVIEW………………………………………………..10
2.1 Introduction…………………………….……………………………………………………10
2.2 Conceptual clarification……………………………………………………………………..10
2.2.1 Credit Risk…………………………………………………………………………….10
2.2.2 Types of credit risk……………………………………………………………………11
2.2.3 Credit events…………………………………………………………………………..13
2.2.4 Assessing Credit Risk…………………………………………………………………14
2.2.5 Analytical Template for Credit Risk Assessment…………………………………..…17
2.2.6 The concept of Performing and Non-performing loans……………………………….18
2.2.7 Credit Risk Management or Credit Management………………………………………20
2.2.8 Credit Risk Management Strategies……………………………………………………21
2.2.9 Reasons for Holding Cash…………………………………………………………..…24
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2.2.10 Target Cash Balance………………………………………………………………….25
2.2.11 Cash Management…………………………………………………………………….25
2.2.12 General Principles of Cash Management……………………………………………..27
2.2.13 Functions of Cash Management………………………………………………………30
2.2.14 Elements or Components of Cash Management………………………………………32
2.2.14.1 Cash Pooling Techniques……………………………………………………32
2.2.15 Cash flow Forecast and Cash flow Statement…………………………………………34
2.2.15.1 Cash flow forecast………………………………………………………….34
2.2.15.2 Cash flow statement…………………………………………………………35
2.2.16 Illiquidity/Liquidity……………………………………………………………….….36
2.2.17 Elements of Liquidity…………………………………………………………….…..38
2.2.18 Liquidity Risk and Liquidity Creation in Commercial Banks…………………….….40
2.2.19 Liquidity Management………………………………………………………………..42
2.2.20 Cash and Credit Management and Liquidity Performance in Commercial Bank……43
2.3 Empirical Review of Literatures…………….………………………………….……………47
2.4 Theoretical Framework…………..…………………………………………………………..56
2.4.1 Loan Pricing Theory……………………………….…………………………………..56
2.4.2 Theory of Multiple Lending……………………………………………………………57
2.4.3 Hold-up and Soft-Budget-Constaint Theories…………………………………………57
2.4.4 The Signalling Arguments……………………………………………………………..58
2.4.5 Credit Market Theory………………………………………………………………….58
2.4.6 The Baumol Theory……………………………………………………………………58
2.4.6.1 Assumptions……………………………………………………………………59
2.4.6.2 Limitations……………………………………………………………………..60
2.4.6.3 Use of Baumol Theory…………………………………………………………60
2.4.7 The Miller Orr Model………………………………………………………………….60
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2.4.8 The Line of Credit Model……………………………………………………………..62
CHAPTER THREE: METHODOLOGY…………………………………………………….73
3.0 Introduction……………………………………………………………………………….….73
3.1 Restatement of the Research Hypothesis…………………………………………………….73
3.2 Research Design………………………………………………………………………………73
3.3 Research Population………………………………………………………………………….74
3.4 Sample and Sampling Technique…………………………………………………………….74
3.5 Research Instruments…………………………………………………………………………75
3.6 Validity and Reliability of Instrument……………………………………………………….75
3.7 Method of Data Collection……………………………………………………………………75
3.8 Data Validation………………………………………………………………………………75
3.9 Data Presentation and Analysis Techniques…………………………………………………76
3.9.1 Multiple Regression Model……………………………………………………………76
3.9.2 Trend Analysis…………………………………………………………………………77
3.9.2.1 Credit Risk Trend………………………………………………………………77
3.9.2.2 Liquidity Performance Trend…………………………………………………..78
CHAPTER FOUR: PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA.
4.0: Introduction…………………………………………………………………………………..79
4.1 Analysis of Results on Panel Data Regression……………………………………….………79
4.2 Graphs Showing the Liquidity Performance in relation to its Credit Risk over Seven years..81
4.3 Analysis and Interpretation of Credit and Liquidity Performance Trend…………………….88
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS…………90
5.1 Introduction…………………………………………………………………………………..90
5.2 Summary of Major Findings…………………………………………………………………90
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5.3 Discussion of Findings……………………………………………………………………….91
5.4 Conclusion……………………………………………………………………………………92
5.5 Recommendations……………………………………………………………………………93
5.6 Contributions to knowledge………………………………………………………….………94
5.7 Areas for Further Studies…………………………………………………………….………94
BIBLOGRAPHY……………………………………………………………………………….95
APPENDIX………………………………………………………………………………….…102

 

CHAPTER ONE

Information
A bank is a financial intermediary and money creator that creates money by lending money to a borrower, thereby creating a corresponding deposit on the bank‟s statement of financial position. Commercial Banks are profit-making organizations acting as intermediaries between borrowers and lenders attracting temporarily available resources from business and individual customers as well as granting loans for those in need of financial support (Drigă, 2012). Commercial banks can also refer to banks or a division of a bank that mostly deals with deposits and loans from corporations or large businesses.
The health of a financial system plays a very important role in the economic development of the country and it failure can have very tragic consequences for such an economy. In developing countries like Nigeria, commercial banks through their functions and activities aid the growth and development of the economy and therefore, are very important to the efficiency and success of the financial system.
Traditionally, it is the belief of every business that profit is a key indicator of success. This is very much true but most business have failed to understand that there is more to profitability than the large figure of retained earnings or reserves in the statement of financial position.
Commercial banks accept deposits from its customers and in turn, generate revenue by lending to individuals and corporate organizations. The statement of financial position of a commercial bank is constituent mostly of loans and advances and bonds as the majority of its asset and deposits as it major liability. This implies that loans make up the bulk of the bank‟s asset and this make it safe to say the life blood of a commercial bank is credit. As a result of lending, credit risk is introduced into the activities of the commercial bank and this is the most critical of all risk faced by the banking institution. If the bank makes bad loans to firms or consumers for example, the bank will be in a crisis if those loans are not repaid (Mavhiki et al., 2012).
As a matter of fact a bank cannot remain in business if it neglects the credit function (Osayeme 2000). Credit risk is of major concern to commercial banks; therefore, commercial banks need to put in place risk management measures to help avoid the risk from blooming into something
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greater than they are able to handle which ultimately is illiquidity. Risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources, but credit risk is the risk of loss due to debtor‟s non–payment of a loan or other line of credit (either the principal or interest or both) (Campbell, 2007). There is need for commercial banks to adopt appropriate credit appraisal techniques to minimize the possibility of loan defaults since defaults on loan repayments leads to adverse effects such as the depositors losing their money, loss of confidence in the banking system, and financial instability (kithinji, 2010). Hence, credit management is made necessary for both profitability and liquidity.
Another aspect fundamental to the survival of a commercial bank is its working capital. The major concern of working capital is cash. Though, cash holds the smallest unit of the total current asset, like the blood stream of the human body, it gives strength and vitality to the business enterprise. Cash is king and this hold true irrespective of the business size. The availability of cash balances is a key determinant of a bank‟s competitive ability because it provides the means to invest in people, technology and assets.
Cash is both the beginning and end of working capital cycle which keeps the business going. Hence, every enterprise has to hold necessary cash for its existence. Moreover, steady and healthy circulation of cash throughout the entire business operations is the basis of business solvency. Now-a-days, non-availability and high cost of money have created a serious problem for industry. Nevertheless, cash like any other asset of a company is treated as a tool of profit. Further, the emphasis is on the right amount of cash, at the right time, at the right place and at the right cost. In the words of R.R. Bari, “Maintenance of surplus cash by a company unless there are special reasons for doing so, is regarded as a bad sigh of cash management as the holding of cash balance has an implicit cost in the form of its opportunity cost.
Cash may be interpreted under two concepts. In narrow sense, “Cash is a very important business asset, but although coin and paper currency can be inspected and handled, the major part of the cash of most businesses is in the form of bank checking accounts, which represent claims to money rather than tangible property.” While in broader sense, “Cash consists of legal tender, cheques, bank drafts, money orders and demand deposits in banks. Thus, we may conclude that in narrow sense cash means cash in hand and at bank but in wider sense, it is the deposit in banks, currency, cheques, bank draft etc. In addition to cash in hand and at bank, “Cash
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management includes management of marketable securities also, because in modern terminology money comprises marketable securities and actual cash in hand or in bank.” Cash management in a commercial bank is therefore indispensable.
1.2 Statement of the problem
One of the major and most crucial problems faced by commercial banks now-a-days is liquidation even after these commercial banks have recorded a high level of profit. It is very disturbing that a commercial bank that seems fine suddenly winds-up and this always leaves the customers wondering “How” and “Why.”
Researches carried out over the course of the past few years on the very devastating financial crisis that rocked the banking industry as a whole in 2008-09 have all shown that most commercial banks ran out of cash as bad debts, lack of short-term financing and poor profitable opportunities combined to cause the most severe crisis in the financial sector for decades. But then the question is; how do banks that are already profitable run out of cash? Or how do banks that are already in business not put in place all possible measures to ensure continuous profitability and liquidity?
As a result of these, the major problem identified by this research work as the reason for the failure of these commercial banks is poor management of their finance (cash and credit). In light of the above, the problems identified by this research work are summarized as follows:
1. The level of exposure to and the impact of credit risk by commercial banks are not met by proper strategies and tactics that will help manage this risk effectively for control purposes.
2. Every time a commercial bank performs it lending function, it introduces credit risk into the business. The exposure to this risk is inversely related to the liquidity position of these banks but they have failed to see how each credit risk they are exposed to has affected their liquidity performance over the years.
3. In order to avoid the high cost associated with holding cash whose opportunity cost is the cost of lost interest, commercial banks keep cash balances which are below the target cash balance.
4. Banks add the amount of cash required to satisfy its transaction needs to that needed satisfy its compensatory balances to produce a target cash balance. This result to surplus cash which if left idle will cause the firm to lose the profit it would have earned if it had been invested.

1.3 Objectives of the study
In the light of problems that have been identified as the major factors that are responsible for the failure of commercial banks in Nigeria, this research work would be used to examine the challenges so as to achieve some specific objectives. The general objective of this study is establishing a relationship between cash and credit risk management and the liquidity of commercial banks. The more specific objectives are:
1. To examine the impact of non-performing loans on the liquidity position of commercial banks.
2. To carefully investigate the influence of effective credit risk management put in place by these banks on their liquidity performance.
3. To show the credit risk exposure and liquidity performance trends of Nigerian commercial banks over a given period of time.
4. To develop, explore and evaluate ways in which commercial banks can achieve their target cash balances to meet their various needs so as to avoid insolvency and aid profitability.
1.4 Research questions
With a view of achieving the specific objectives stated above, the answers to the following questions are required:
1. To what extent does non-performing loans affect the liquidity position of commercial banks?
2. What influence does effective credit risk management have on the liquidity performance of commercial banks?
3. What relationship exists between the trend of credit risk and the trend of liquidity performance of commercial banks over time?
4. Why do commercial banks have to achieve their target cash balances in order to avoid insolvency?
1.5 Research hypothesis
From the subsequently stated research objectives and questions, the following assumptions have been made stated both in their null and alternate form as regard the already identified problems of this study and are going to be tested during the course of this study:

Hypothesis 1:
H0: There is no positive and significant relationship between effective credit risk management and the achievement of target cash balances and the insolvency or liquidity performance of commercial banks.
H1: There is a positive and significant relationship between effective credit risk management and the achievement of target cash balances and the insolvency or liquidity performance of commercial banks.
Hypothesis 2:
H0: Liquidity performance is not affected by increases in credit risk levels in Nigerian commercial banks.
H1: Liquidity performance tends to decrease with the increase in credit risk levels in Nigerian commercial banks.
1.6 Significance of the study
Conducting this study would enable the researchers expand their horizon of knowledge on the importance of cash and credit risk management for commercial banks to enable them make profit and secure liquidity.
This study will enable Commercial banks see reasons to adopt and implement effectively and efficient risk management policies in order to tackle the different types of risk that arise in the course of carrying out their functions.
This study will also enable statutory and regulatory authorities formulate laws and set-up guidelines that will aid commercial banks and other banking institutions in managing all assets and liabilities towards the achievement of profit and maintaining a high liquidity position.
This study is carried out also with a view of enhancing the understandability and comprehensive ability of students, teachers and lecturers on the concepts; cash management, credit management and liquidity.
Further studies can also be carried out by other scholars on this research work so as to further the advancement of the quest for knowledge.

1.7 Scope of the study
This study will be carried on a certain number of firms who have met certain conditions which includes listing on the Nigerian stock exchange and the availability of consistent and regular financial statements among others. This research would be carried out in Nigeria. This study is limited to banks only; commercial banks to be specific. In order to attain a sample population that is neither too large nor too small, five commercial banks have been selected and a time frame of seven years has also been employed for the purpose of this study. This time period will run from the year 2006 to the year 2012. The analysis will be carried out of the audited financial statements of the selected commercial banks.
1.8 Limitation of the study
In the course of this study, certain challenges were encountered and this imposed a constraint on the gathering of information or data needed to proffer a dependable solution to the problems stated in the above section of this study:
1. Time frame: the period of time assigned to the execution of this project was very little as compared to the amount or bulkiness of the data needed for this study. This limited the ability to obtain enough information as deadlines needed to be met.
2. Accessibility to information; obtaining the data used for this research work did not come easy as most of the bankers were not willing to corporate or were hoarding information relatively important to the conclusions of the study.
3. Also, obtaining permission to leave the premises of the school for the purpose of this research was made difficult as several strains were placed on the means of obtaining an exeat from the school authorities.
4. The cost of carrying out this research was unavoidably high. Costs of obtaining materials, cost of transportation and other cost; necessary and unavoidable in order to ensure the success of this project were very expensive especially when viewed from the perspective of a student.
5. This study caused the researcher to joggle the carrying out of this research study with other school activities, academic and extra-curricular which placed a strain on the time available to carry out other activities and left very little time for sleep.
1.9 Organization of the study
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This study for the purpose of this research work is structured into five chapters. The first chapter, also referred to as chapter one was used to introduce the research work in which was contained; the background information, statement of the problem, the objectives of this study, research questions, research hypothesis, significance of the study, scope of the study, limitations, organization and the definition of several terms used in study. The second chapter (chapter two) shall be used to review various literatures while clarifying certain concepts, theoretical framework and doing an analytical review. The methodology adopted in the course of this research shall be discussed in chapter three after which the analysis of the data obtained will be done in chapter four. Finally, the summary, conclusions and recommendations as regards the findings will be represented in chapter five.
1.1 Definition of Terms
1. Financial system: this is the interplay of financial companies, regulators and institutions operating on a supranational level. The financial system is possibly the most important institutional and financial vehicle for economic transformation. A financial system objective is to supply funds to various sectors and activities of the economy in ways that promote the fullest possible utilization of resources without the destabilizing consequence of price level changes or unnecessary interference with individual desires.
2. Economic development: this refers to progress in an economy or the qualitative measure of this. Economic development usually refers to the adoption of new technologies, transition from agriculture-based to industry-based economy, and general improvement in living standards of people.
3. Credit: it is the trust which allows one party to provide money or resources to another party where that second party does not reimburse the first immediately (thereby generating a debt), but instead arranges either to repay or return those resources( or other materials of equal value) at a later date.
4. Credit risk: It is the possibility of losing the outstanding loan partially or totally, due to credit events (default risk), failure to pay a due obligation, repudiation/moratorium or credit rating change and restructure. Credit risk arises from the potential that an obligor is either unwilling to perform on an obligation or its ability to perform such obligation is impaired resulting in economic loss to the bank.

5. Retained earnings and reserves: retained earnings are the percentage of the business profits not distributed to shareholders, to corporate investors or to vendors as part of continuing financial obligations.
6. Working capital: It is a financial metric which represents operating liquidity available to a business, organization or other entities including governmental entities. It also refers to the net liquid assets computed by deducting current liabilities from current assets. It is the cash available for day-to-day operations of an organization.