The effects of liquidity management on the profitability of commercial banks

Abstract

Liquidity is to banks as blood is to a human being, in corporate finance, liquidity management and profitability is widely debated areas. Liquidity management plays a dynamic role in determining the effectiveness of the banking sector with potential influence in smooth functioning.  

This study was aimed at determining the effects of liquidity management on the profitability of commercial banks case study of NFC bank Buea branch, other specific objectives of the study include;

To examine how ineffective management of cash on the profitability of commercial banks, to find out the problems associated with liquidity management, to identify the sources of bank liquidity, from these research objective other research questions were formulated and hypothesis stated in both the null and alternative form.

The dependent variable of the study was profitability and the independent variable was liquidity management, this study adopted the descriptive research design with a total sample size of 20 respondents using a questionnaire for the collection of primary data. Also, the random technique was used for this study.

Results of the study reveal that Ineffective liquidity management can cause the bank to borrow from the central bank usually with a higher interest rate.

More so it was found that balances and reserve held with the central bank were used as sources of liquidity by NFC bank.

The study concluded that there was a positive causal relationship between liquidity management and bank profitability (NFC Bank).

The study recommended that The Bank should provide adequate training to the concerned staff members as to the utilization and analysis of liquidity measurement tools, and that management should maintain enough cash to meet its day-to-day operating expenses.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Liquidity is the lifeblood of every business. All businesses, financial institutions and organizations need liquidity to operate or function properly.  Banks borrow short term and lend long term giving liquidity risk the chance to prevail from the inevitable mismatch.

It is therefore important for banks to efficiently and effectively manage their liquidity so as to make enough profits and as well balance liquidity and profitability to attain their main objective which is to be liquid, profitable, and safe.

Liquidity management and profitability are very important in the development, survival, sustainability, growth and performance of banks, companies and the economy as a whole.

Profitability does not mean liquidity in all cases. A company may be profitable and not liquid. Therefore, liquidity should be managed in order to obtain optimal levels.

That is a situation or level that avoids excess liquidity which may translate to the poverty of ideas by management.

Also, inadequate liquidity levels may lead to the inability of the organization to meet its short-term obligations as they fall due.

Because of this, banks are developing various strategies to improve their liquidity position therefore and bring down the profitability of the bank.

Liquidity is a financial term that means the amount of capital that is available for investment. Today most of this capital is a credit, not cash. Bank liquidity simply means the ability of cash. Bank liquidity simply means the ability of a bank to maintain sufficient funds to pay for its maturing obligations.

It is the banks’ ability to immediately meet cash, cheques, other withdrawal obligations and legitimate new loan demands while abiding by existing reserve requirements.

Nwaezeaku (2008) defined liquidity as the degree of convertibility to cash or the case with which an asset can be converted to cash sold at a pair market prize.

Liquidity management of financial institutions (banks) and other economic units have remained fascinating and intriguing, though very exclusive in the process of investment analysis Vis a Vis bank portfolio management.

There appear to be an unending argument in the literature over the years on the role, meaning and determinants of liquidity management (Agbada et al 2013)

Firms should manage their credits in such a way that sales are expanded to an extent to which risk remains with an acceptable limit. These costs include: The credit administration expenses, debt, losses and opportunity cost of the fund in receivables, the aim of liquidity management should be to regulate and control these cost that cannot be eliminated together (Berger,2008).

A liquid bank is one that stores enough cash equivalents together with the ability to raise finance or funds quickly from sources to enable it to meet its payment obligation and financial commitments as they fall due in due time.

In addition, liquidity management is a concept that is receiving serious attention all over the world especially because of the state of the economy and the world financial crisis which brought about some changes in liquidity management, proposed regulations, limited credit extensions increase in cash reserves, higher management standards, increase monitoring on loan granting etc.

Some of the striking corporate goals include; the need to maximize profit, maintain high levels of liquidity in order to guarantee safety, attainment of other corporate objectives.

The importance of liquidity management as it affects corporate profitability in today’s business cannot be emphasized. The tradeoff between liquidity and profitability has been a burning issue in the corporate world. Theoretically; both liquidity and profitability are affected by the working capital decisions of any company or banks. Excess of investment in working capital may result in low profitability and lower investment may result in poor liquidity.

Therefore, the management needs to trade. Between liquidity, profitability to maximize shareholders wealth. Every organization, whether profit-oriented or not irrespective of the size and nature of the business, requires a necessary amount of working capital is the most crucial factor for maintaining liquidity, survival, solvency and profitability of the business (Mukhopadhyay, (2004).

Liquidity plays a significant role in the successful functioning of a business firm. A firm should ensure that it does not suffer from a lack of excess liquidity to meet its short-term obligations. A study of liquidity is of the major importance of both the internal and external analysis because of its close relationship with day to day operations if a business (Bhunia 2012)

Historically, banks must face a certain degree or type of risk which may have a severe impact on the economy or financial system and economic system as a whole. This is why banks, governmental entities and private industries have tried to understand liquidity risk and implement public policy, regulations, and risk assessment policies to mitigate this risk.

1.2 Problem Statement

The need for liquidity by any business or financial institution is just like the need for blood by the human system. adequate liquidity is good and will help the firm to meet depositors demand, carry out day to day operations, hedge cash flow problems, and also to make revenue payments just to name a few. 

However, if liquidity is in excess or shortage, it poses a problem. Excess liquidity will cause the following problems for the central bank and the economy in general. It can reduce the effectiveness of the monetary transmission mechanism especially in affecting the demand site to reach the targeted inflation. Shortages in liquidity too will cause bankruptcy, liquidation, an increase in demand for cash by depositors and defaults etc.

Commercial banks wholly depend on deposits made by their clients or customers and most of their operations are carried out through the deposits. In situations where all the depositors withdraw their cash from accounts, the bank is likely to face a liquidity management trap.

This may lead to borrowing funds from the central bank or other banks at very high-interest rates or cost which reduces profitability. This threatens the survival of commercial banks in Cameroon.

Due to this, commercial banks have tried to ensure that they hold adequate funds at all times so that they are able to meet the demand of depositors. It is for this reason that it is necessary to study the effect of liquidity management on the profitability of commercial banks in Cameroon, precisely in Buea municipality with the case of National Finance Credit (NFC) Bank Buea.

Research Questions

The main research question was What the effect of liquidity management on the profitability of commercial banks?

1. What is the impact of ineffective management of cash on the profitability of commercial banks?
2. What are some of the problems associated with liquidity management?
3. What are some the sources of bank liquidity?

1.3 Objectives of the Study

The main objective of this study is to determine the effects of liquidity management on the profitability of commercial banks. The specific objectives of the study include;

1. To examine how ineffective management of cash on the profitability of commercial banks?
2. To find out the problems associated with liquidity management.
3. To identify the sources of bank liquidity