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The Project File Details
This study examined the impact of liquidity on the performance of commercial banks in Nigeria from 2000 to 2015. Profit before tax was used as proxy for dependent variable while liquidity ratio (LQR), lending interest rate (INTR) and exchange rate (EXR) were used as proxies for explanatory variables. The study used descriptive statistics and Ordinary Least Squares (OLS) for data analysis.The study finds that liquidity ratio [2.43311] significantly affected profit before tax; lending interest rate on the other hand significantly [2.1924] affected profit before tax within the study period. The coefficient of determination (R2 = 0.4343) means that about 43% of the changes in the dependent variable was explained by the independent variables included in the model. Based on the results and findings of the study, we recommend that: commercial banks should give priority to their liquidity ratio by expansion of credit creation activities and reduction of high risk off-balance sheet activities; commercial banks should further reduce their interest rate in order to attract more borrowers as this will increase their liquidity position as well as profitability.
1.1 Background of the Study
Liquidity is a concept that many investors fail to take into account or understand and as a result their financial plans fail to come through in such critical times as retirement or college funding for a dependent. However, the fact is liquidity or a lack thereof it causes more financial problems than almost any other aspect of finance. People either lose money, which they needed in the short term because of improper investments or they find they have insufficient funds upon retirement because of years of investing in short term investments for a long-term goal (Central Bank of Barbados, 2008). Businesses use a variety of financial performance evaluation measures to analyze the results of their actions. Investors perform a variety of calculations to review the actions of a particular company’s financial performance. Both company management and investors spend time focusing on the company’s liquidity to ascertain its level of financial performance. Certain financial ratios provide important information regarding a company’s liquidity, for example, bill payment. The primary reason liquidity ratios require attention involves the company’s ability to pay its bills. Liquidity ratios compare the current assets of a business to the current liabilities (Akhtar, 2007).
Banks are germane to economic development through the financial services they provide. Their intermediation role can be said to be a catalyst for economic growth. The efficient and effective performance of the banking industry over time is an index of financial stability in any nation. The extent to which a bank extends credit to the public for productive activities accelerates the pace of a nation’s economic growth and its long-term sustainability.
The Nigerian banking industry has been strained by the deteriorating quality of its credit assets as a result of the significant dip in equity market indices, global oil prices and sudden depreciation of the naira against global currencies (BGL Banking Report, 2010). The poor quality of the banks’ loan assets hindered banks to extend more credit to the domestic economy, thereby adversely affecting economic performance. This prompted the Federal Government of Nigeria through the instrumentality of an Act of the National Assembly to establish the Asset Management Corporation of Nigeria (AMCON) in July, 2010 to provide a lasting solution to the recurring problems of non-performing loans that bedeviled Nigerian banks. According to Ahmad and Ariff (2007), most banks in economies such as Thailand, Indonesia, Malaysia, Japan and Mexico experienced high non-performing loans and significant increase in credit risk during financial and banking crises, which resulted in the closing down of several banks in Indonesia and Thailand.
Liquidity is important because lack of adequate liquidity in commercial banks is often characterized by the inability to meet daily financial obligations. At time it may have the risk of losing deposits which erodes its supply of cash and thus forces the institution into disposal of its more liquid assets. However, the problems of weak corporate governance, poor capital base, illiquidity and insolvency, poor asset quality and low earnings are some of the constraints faced by the banking system. The impact of liquidity is invariably used to assess the performance of financial firms hence its importance shall not be eluded. Sequel to the aforementioned, this study was driven to assess the impact of liquidity on the performance of commercial banks in Nigeria. Also, the study was motivated by the damaging effect of classified assets on bank capitalization and would be of utmost relevance as it addresses how credit risk affects banks’ profitability using a robust sample and the findings would serve as the basis to provide policy measures to the various stakeholders on how to tackle the effect of credit risk in order to enhance the quality of banks’ risk assets.
1.2 Statement of the Problem
Liquidity has a significant positive effect on financial performance. Bank companies under going restructuring to achieve their goals have to consider its liquidity management. Liquidity is the ability of the business to meet its cash obligations within a specific period. For instant liquidity is best measured with cash flow statements or budgets.
Liquidity plays a significant role in determining success or failure of firm in business performance due to its effect on firm’s financial profitability (Eljelly, 2004). The financial institutions may face serious consequences if it is not properly managed. The banks and the regulatory authorities are becoming increasingly vigilant of the liquidity positions held by financial institutions (Muranaga and Ohsawa, 2002). The deposits are the lifeline of the banking business. Most of the banking operations are run through deposits. If the depositors start withdrawing their deposits from the bank, it will create a liquidity trap for the bank forcing the bank to borrow funds from the central bank or the inter‐bank market at higher costs (Plochan, 2007).
In Nigeria, the commercial banks are faced with challenges of financial performance. This is seen in the fact that when the firms have problems with financial performance, they may defer their payments to creditors which is harmful for companies and can result in severe consequences such as worse credit terms in the future. This in the long run adversely affects profitability when working capital is the money needed to finance the daily revenue generating activities of the firm. So, if this continues will cause a number of problems to not only the firm who depend so much on this liquidity management, but also the various stakeholders in the banking industry. It was evident that research in the area of Liquidity management has not been done in a more comprehensive approach. The study research gap is demonstrated by the scarcity of empirical studies on impact of liquidity on the performance of commercial banks in Nigeria. Empirical studies (Nwakaego, 2014; Lawrence, 2013; Zir and Afza, 2009), were inadequate as they concentrated on liquidity management of other industries in Small and Medium Enterprise. For banks to remain competitive, emphasis should be made on liquidity management and profitability with regards to their ability to manage financial performance.
This study will focus on the impact of liquidity on the financial performance of Commercial Banks in Nigeria.
1.3 Research Question
The following probing questions become very pertinent:
1.4 Objectives of the Study
The major objective of the study is to access the impact of liquidity on the performance of commercial banks in Nigeria and the specific objectives includes the following;
1.5 Research Hypothesis
However, to give more emphasis and achieve these objectives we hypothesized that:
H01: There is no significant impact of liquidity ratio on the performance of commercial banks in Nigeria.
H02: There is significant impact of lending interest rate on the performance of commercial banks in Nigeria.
1.6 Significance of the Study
The findings of this study will be resourceful to commercial banks since they will understand the impact of liquidity on financial performance of the firm. From these findings commercial banks can determine the proper match between assets and liabilities to maintain proper levels of liquidity. This study could be used as an initiation for those who are interested to conduct a detailed and comprehensive study in relation to liquidity risk and financial performance of firms or other related topics.
This study hopes to shed more light on the governing bodies and regulators of microfinance institutions and risk management departments of financial institutions to be aware of about liquidity and financial performance of the firm.