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One of the major indicators of financial performance is profitability .Every stakeholder in the banking sector is interested in liquidity and performance(profitability)of the bank, the Shareholders are interested in profitability of the bank because it determines their returns on investment. Depositors are concerned with the liquidity position of their banks because it determines the ability of the bank to response to their withdrawal needs, which are normally on demand or on a short notice as the case may be. The tax authorities are interested in the profitability of the bank in order to determine the appropriate tax obligation to the government.
In a bid to see how the interest of the various stakeholders could be protected, the effects of liquidity on the loan portfolio performance of Nigerian Banks was examined. This study found out whether liquidity proxies(loans to deposit ratio and liquidity ratio) have significant impact on the loan portfolio performance (Profitability) of Nigerian banks with Lending spread as proxy for loan performance.
To achieve the objectives of this research, a quantitative research method (secondary data) was adopted. Using purposive data collection approach, the study carried out a time series, cross
sectional analysis on the 12 banks listed on the Nigerian Stock Exchange over a period of 8 years from 2008 to 2015. The selection of the banks was determined by data availability for the period and the data were retrieved from the Annual financial reports of the 12 banks as obtained in the Nigerian Stock Exchange (NSE) and the respective banks’ websites. Panel data regression analysis from Stata statistical software was employed to analyse the data.
The study concluded that there is significant negative impact of both liquidity ratio and loan to deposit ratio on lending spread.That means, profitability is significantly but negatively influenced by liquidity.
Keywords:Liquidity, Loan portfolio, Lending Spread, Profitability, Loans-to- deposit ratio
Word Count: 311
Table of Contents vi
CHAPTER ONE: INTRODUCTION
1.1 Background to the Study 1
1.2 Statement of Problem 2
1.3 Objective of the Study 2
1.4 Research Questions 3
1.5 Hypothesis 3
1.6 Significance of the Study 3
1.7 Scope of the Study 3
1.8 Operational Definition of Term 3
CHAPTER TWO: REVIEW OF LITERATURE
2.0 Introduction 5
2.1 Theoretical Framework 5
2.1.1 Concept of Liquidity 5
2.1.2 Concept of Loan Portfolio 5
22.214.171.124 Loan Performance 5
126.96.36.199 Loan Classification 6
2.1.3 Evolution of Banks in Nigeria 7
2.1.4 Nigerian Banking Reforms and Policies 8
188.8.131.52 G.D. Paton Report 8
184.108.40.206 Central Bank Act, 1958 8
220.127.116.11 Companies Act of 1968 9
18.104.22.168 The 2004-2005 Banking Capitalization Reform 9
22.214.171.124 Cash-less Nigeria policy 2012 9
2.2.0 Review of Variables 10
2.2.1 Liquidity 10
126.96.36.199 Loan-To-Deposit Ratio – LTD 10
188.8.131.52 Liquidity Ratio-LQDR 10
2.2.2 Profitability 11
184.108.40.206 Lending rate 11
220.127.116.11 Deposit rate 11
18.104.22.168 Lending Spread 11
2.3 Theoretical Review 11
2.3.1 Commercial Loan Theory 12
2.3.2 Shiftability theory 12
2.3.3 Anticipated Income Theory 13
2.3.4 Liability management Theory 13
2.4 Empirical Review 14
2.4.1 Summary and gap in the literature 21
CHAPTER THREE: METHODOLOGY
3.0 Introduction 22
3.1 Research Design 22
3.2 Population 22
3.2.1. Sample size and sampling Technique 22
3.3 Method of Data Collection 23
3.4 Method of Data Analysis 23
3.5 Model Specification 23
3.6 Model Estimation Technique 23
3.7 A priori Expectation 24
3.8 Ethical issues 24
CHAPTER FOUR: DATA ANALYSIS, RESULTS
AND DISCUSSION OF FINDINGS
4.0 Introduction 25
4.1 Descriptive Analysis of variables 25
4.2 Trend Analysis of Liquidity Position of Nigerian Banks 27
4.2.1. Comparative Analysis of Bank Liquidity Ratio in Nigeria 29
4.3 Correlation Analysis 31
4.4 Panel Regression Results Analysis 32
CHAPTER FIVE:SUMMARY, AND CONCLUSION AND RECOMMENDATIONS
5.0 Introduction 34
5.1 Summary 34
5.1.1 Findings from the descriptive analysis 34
5.1.2 Findings from the empirical analysis 34
5.2 Conclusion 34
5.3 Recommendations 36
5.4 Limitation of the Study 36
5.5 Contributions to Knowledge 36
5.6 Suggestions for Further Studies 36
1.1 Background to the Study
The importance of liquidity and profitability of banks has received tremendous attention in the corporate world in recent years. The management of corporate liquidity is one of the most critical areas in determining whether a firm will be profitable or not. Liquidity of a firm represents its ability to carry out all its financial obligations without affecting the business operations. A business cannot run smoothly without the presence of adequate working capital. Therefore, the importance of liquidity makes it necessary for banks to maintain a reasonable amount of their assets in the form of cash in order to meet their short term obligations. According to Saleh, (2014), profit is the bottom line or ultimate performance result showing the net effects of bank policies and activities in a financial year.
Profitability being a measure of loan performance also refers to excess of firm’s revenue over her operational cost or measurement of the rate of return on investment. Enhancement of profitability is one of the ultimate goals of every firm, and generally, banks strive to strike a balance between profitability and liquidity (Niresh, 2012).
The Basel Committee on Banking Supervision (2008) defined liquidity as the ability of a bank to fund increases in assets and meet obligations as they fall due, without incurring unacceptable losses. Liquidity could be risky when a financial firm, though solvent, either does not have enough financial resources to allow it to meet its obligations as they fall due, or can obtain, such funds only at excessive cost (Vento & Laganga, 2009).
Liquidity risk appears when there are differences between the size and maturity of assets and liabilities on the balance sheet. There are generally two types of liquidity risks which are funding liquidity risk and market liquidity risk. Funding liquidity risk is the risk that the bank is not able to respond effectively to current needs as well as future cash needs without affecting its daily operations and financial condition. Market liquidity risk is defined as the risk that a bank cannot easily offset or eliminate a position without significantly affecting the market price (Ferrouhi & Lehadiri, 2014).
Profitability and liquidity as performance indicators are important to the major stakeholders of any firm and banks in particular. The shareholders are interested in the profitability of banks because it determines their returns on investment. Depositors are concerned with the liquidity position of their banks because it determines the ability to respond to their withdrawal needs, which are normally on demand or on a short notice as the case maybe. The tax authorities are interested in the profitability of the banks in order to determine the appropriate tax obligation (Olagunji, Adeyanju & Olabode, 2011). This study examined the effect of liquidity on the loan portfolio performance (profitability) of Nigerian banks in other to contribute to the gaps in the previous studies as stated below.
1.2 Statement of the Problem
In Nigeria and the competitive world, the banking sector has emerged as a key player, contributing its best to create employment, and improving the financial sector of the country. With the current and growing trend in Nigeria economy, it has become a challenge for the sector to create employment and contribute meaningfully to the economy due to inability to earn maximum profitability. Therefore, it is necessary for banks to take dynamic decisions to effectively manage their assets, particularly loan portfolio in order to bring about the needed improvement in their profitability.
Moreover, considering the public loss of confidence as a result of distress which bedevilled the financial sector especially banks in the recent past; and the intensity of competition in the banking sector due to the emergence of new banks, every deposit money bank should ensure that it operates profitably and at the same time meets the financial demands of its depositors by maintaining adequate liquidity (Olagunji, Adeyanju, & Olabode, 2011).
Deposit money banks are often confronted with the problem of how to choose and identify the optimum point or the level at which it can maintain its assets in order to optimize the set objectives (Ajibike &Aremu, 2015). This investigated the effect of liquidity (the proportion of the deposits that may be demanded by the depositors at any particular time) on the profitability of banks. It will investigated liquidity position of banks in Nigeria.
1.3 Objective of the Study
The main objective of the study is to examine how liquidity position of Nigerian banks affects their financial performance. The specific objectives are to:
A null hypothesis has been formulated for this study which is:
H0: There is no significant relationship between liquidity and bank profitability
1.6 Significance of the Study
This study would be of immense value to investors, regulators, Managers, academia and other relevant stakeholders. By relating liquidity to loan portfolio performance using lending spread as proxy for profitability, the study would provide future researchers with an alternative measurement area which has little or no research within the Nigerian context. This study evaluated banks’ liquidity position and how it affects their profitability.
Various studies on liquidity and bank’s profitability concentrated on macroeconomic factors like Inflation and exchange rate, while a few concentrated on firm level. This study employed firm level data to examine the impact of liquidity on bank loan portfolio performance in Nigeria.
Furthermore, the reports from empirical studies on the subject matter still remain inconclusive. For instance, Ajibike and Aremu (2015) reported positive relationship between liquidity and profitability but, Olanrewaju and Adeyemi (2015) reported no significant relationship, while Eljelly, (2004) and Dahiyat, (2016) concluded that there is negative relationship between liquidity and profitability. The lack of consensus among literatures clearly shows that further study needs to be carried out. Also, this study differs from existing literatures that examined the relationship between liquidity and profitability by the use of Lending spread as proxy for measuring bank’s loan portfolio performance (profitability) whereas others used either Return on Assets(ROA) or Return on Equity (ROE).
1.7 Scope of the Study
The study covered 12 of the 22 deposit money banks listed on the Nigerian stock exchange as at Dec. 2015 over a period of 8 years from 2008 to 2015.
1.8 Operational Definition of Terms
Liquidity: This is the ability of a bank to fund increases in assets and meet obligations as they fall due, without incurring unacceptable losses.
Loan Portfolio: This refers to total of all loans held by a bank or finance company on any given day.
Profitability: Profitability is ability of a bank to use its resources to generate revenues in excess of its expenses.
Bank: This is an establishment authorized by a government to accept deposits, pay interest, clear cheques, make loans, act as an intermediary in financial transactions and provide other financial services to its customers.
Loan: An amount of money advanced at interest by a bankto a borrower, usually on collateral security, for a certain period of time.
Lending Spread: This refers to the difference in borrowing and lending rates of financial institutions (such as banks) in nominal terms. i.e the difference between interest paid on deposit to customers and the interest charged on loans and advances.
Deposit: This refers to money placed in banking institutions for safekeeping.
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