THE IMPACT OF LIQUIDITY MANAGEMENT ON THE PERFORMANCE OF FINANCIAL INSTITUTION IN CAMEROON: CASE STUDY BICEC BANK

Abstract

Increasing competition and globalization have fetched the need for effective liquidity management, financial institutions are now required to pay keen attention to their liquidity management. The study sought to investigate the effects of liquidity management on the financial performance of commercial banks in Fako Division, case of BICEC Bank, evaluate the effect of cash reserve ratio, loan to deposit ratio, and liquidity coverage ratio on the financial performance of BICEC Cameroon and to make a recommendation.

This study adopted a longitudinal research design, using Secondary data from 2016 to 2020 to analyze variables of the study. Also, this study used Return on Equity to measure financial performance, cash reserve ratio, Loan to deposit ratio, Liquidity coverage ratio was used as proxies for liquidity management.

Inferential statistics were conducted where correlation analysis was used to study the association between the variables and regression analysis was undertaken to study the relationship between the independent variables and the dependent variable.

From the analysis, the study found out that the credit reserve ratio, loan to deposit ratio, and liquidity coverage ratio position have a positive correlation with the financial performance of BICEC. The regression analysis results indicated that the variability in the profitability of BICEC is 88.4% explained Credit reserve, loan to deposit, and liquidity coverage ratios.

The study results were found to be 85.9% reliable and therefore the model was a good fit in explaining the effect of liquidity management on the financial performance of BICEC. The study concluded financial performance and loan to deposit ratio also have a positive relationship. They should ensure that they have enough liquidity to meet customer withdrawals.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Liquidity management is a concept that is gaining traction around the world, particularly in light of present financial circumstances and the health of the global economy. Business owners and managers throughout the world are concerned about devising a strategy for managing their day-to-day operations in order to satisfy their obligations as they become due while also increasing profitability and shareholder value (Don, 2020).

Liquidity management is a critical goal for financial organizations, not only because it keeps banks from running out of cash, but also because it influences their earnings.  In managing its assets and liabilities in the wake of uncertainties in cash flows, cost of funds, and return on investments, a bank must ascertain its trade-off between risk, return and liquidity (Mashok (Placeholder1)o, 2020). Indeed, studies in other countries across the globe have attributed bank failures to poor liquidity management.

This is so because scholars argue that one of the major contributors to the Global Financial crisis of 2007-2008 was poor liquidity management (Adalsteinsson, 2014). This was large as a result of the collapse of Lehman Brothers, a leading Investment Bank which ended up spreading across the globe through the “contagion effect”.

According to Choudhry (2011), liquidity management refers to the funding of deficits and investment of surpluses, managing and growing the balance sheet, as well as ensuring that the bank operates within regulatory and stipulated limits. Ideal bank management is an uninterrupted endeavour of assuring that a balance exists between liquidity, profitability, and risk (Banks, 2014). Banks indeed require liquidity since such a large proportion of their liabilities are payable on demand (deposits) but typically the more liquid an asset is, the less it yields.

Hence, the decision to choose a particular combination of assets over another, taking into consideration the liability side of a bank, would have a massive effect on bank liquidity management, profitability, and risk (Choudhry, 2012). In managing its assets and liabilities in the wake of uncertainties in cash flows, cost of funds, and return on investments, a bank must ascertain its trade-off between risk, return and liquidity (Landskroner & Paroush ,2011).

Sound liquidity management is an important objective of commercial banks, not only because it prevents banks from running into liquidity shortages but also because it determines their profits. Munyambonera (2010), Olweny & Ongore, and Kusa (2013), as cited in Lukorito et al (2014) have not only identified profitability as the primary objective pursued by commercial banks, but have also recognized that profits are a necessity for successful banking in this era of stiff competition in financial markets, and financial managers are committed to meeting that objective.

Though liquidity management has always been a priority in most banks, the aftermath of the global financial crisis and lessons learned from it have renewed concerns on bank liquidity issues. In a state of turmoil in banking markets, customers can withdraw their deposits at any time and this can lead to bank runs that can lead to costly liquidation of assets of even large banks.

The liquidity of banks allows them to grant credits and consequently stimulate investment and growth. To Civelek & Al-Alami (1991), since commercial banks are the primary suppliers of funds to firms, the availability of bank credit at affordable rates is of crucial importance to firm investments, and consequently, to the health of the economy.

During the 2007-2009 global financial crises several banks experienced some difficulties because they failed to manage liquidity in a prudent manner. Thus, the crisis emphasized the importance of liquidity to the proper functioning of financial markets and the banking sector (Marozva, 2015).

According to Pradhan and Shrestha (2016), the liquidity risk of banks arises from the funding of long-term assets by short-term liabilities, thereby making the liabilities subject to rollover or refinancing risk. Further, the liquidity risk is usually of an individual nature, but in certain situations may compromise the liquidity of the financial system as well (Pradhan and Shrestha, 2016).

Though liquidity management has always been a priority in most banks, the aftermath of the global financial crisis and lessons learned from it have renewed concerns on bank liquidity issues. In a state of turmoil in banking markets, customers can withdraw their deposits at any time and this can lead to bank runs that can lead to costly liquidation of assets.

Liquidity management, therefore, involves the strategic supply or withdrawal from the market or circulation of the amount of liquidity consistent with the desired level of short-term reserve money without distorting the profit-making ability and operations of the bank. It relies on the daily assessment of the liquidity conditions in the banking system, so as to determine its liquidity needs and thus the volume of liquidity to allot or withdraw from the market.  The liquidity needs of the banking system are usually defined by the sum of reserve requirements imposed on banks by a monetary authority (Njimanted et al., 2017).

The relationship between liquidity and performance is critical to banks. It is generally understood that efficiently monitored liquidity levels lead to good financial results. Effective liquidity management creates good public confidence in the financial system of a country and consequently in the liquidity state of banks.

This can lead to a better return on the bank’s assets (Onyekwelu, Chukwuani & Onyeka, 2018). Ibrahim and Aqeel (2017) underscored the need to make optimum use of liquid funds for investments to enhance profitability, keeping aside adequate funds for meeting operational commitments. Excessive levels of liquid funds will negatively affect profitability, while low levels of liquidity can adversely affect the smooth functioning of banks (Ware, 2015). This means that banks should make trade between liquidity and profitability in order to boost business profit (Bagh, Razzaq, Azad, Liaqat & Khan, 2017).

According to Nwankwo (1991), adequate liquidity enables a bank to meet three risks. First is the funding risk – the ability to replace net outflows either through withdrawals of retail deposits or nonrenewal of wholesale funds. Secondly, adequate liquidity is needed to enable the bank to compensate for the non-receipt of the inflow of funds if the borrower or borrowers fail to meet their commitments.

The third risk arises from calls to honor maturity obligations or from requests for funds from important customers. Adequate enables the bank to find new funds to honour the maturity obligations such as a sudden upsurge in borrowing under atomic or agreed lines of credit or to be able to undertake new lending when desirable. For instance, a request from a highly valued customer. Adequate liquidity is also needed to avoid forced sale of asset at unfavourable market conditions and a a heavy loss.

Adequate liquidity serves as a vehicle for profitable operations especially to sustain the confidence of depositors in meeting short-run obligations. Finally, adequate liquidity guides against involuntary or non-voluntary borrowing from the regulatory authorities where there is a serious liquidity crisis, the bank is placed at the mercy of the Central Bank, and hence the control of its destiny may be handed over.

The importance of liquidity management as it affects corporate profitability in today’s business cannot be overemphasis. The crucial part in managing working capital is required to maintain its liquidity in day-to-day operation to ensure its smooth running and meets its obligation. Liquidity plays a significant role in the successful functioning of a business firm.

A firm should ensure that it does not suffer from lack-of or excess liquidity to meet its short-term compulsions. A study of liquidity is of major importance to both internal and external analysts because of its close relationship with the day-to-day operations of a business (Musaed, 2020). The dilemma in liquidity management is to achieve the desired tradeoff between liquidity and profitability (Raheman, 2007).

The liquidity requirement of a firm depends on the peculiar nature of the firm and there is no specific rule on determining the optimal level of liquidity that a firm can maintain in order to ensure a positive impact on its profitability.

The Financial institution sector in Cameroon is still in its infancy and is dominated by the proliferation of foreign banks. By December 2009, there were twelve Financial institutions operating in Cameroon, with only three names, National Financial Credit, Afriland First Bank, and Financial institution of Cameroon as indigenous banks. This makes up about 75% of foreign dominance. The financial landscape of Cameroon has however experienced some evolution over the past decades, particularly in the financial institution’s sector, where many microfinance institutions have surfaced.

According to Njimanted et al (2017) From 400 to about 652 microfinance establishments in the country at the end of 2008, a progress of 10% compared to 2007Of this number, the Cameroon Cooperative Credit Union League (CamCCUL) occupies a relatively large proportion; 177 credit unions.

However, by 2015, there were 418 accredited microfinance institutions in the country (Ministry of Finance (MINFI), 2015). Financial institution activities have equally increased in coverage and depth with the number of banks increasing from 9 in 1999 to 12 by January 2010 and to 14 in 2016 with branches all over the urban centers in the country.

Capital market development has in addition increased the intermediation role of banks within the financial landscape of Cameroon although, with only two companies quoted in the capital market, Financial institutions in Cameroon are gradually getting involved in the process of enabling companies to go public through the Initial Public Offering (IPO).

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 management and implement public policy, regulations, and risk assessment policies to mitigate this risk of liquidity.

1.2 Statement of the problem

Liquidity management and performance are very vital in the development, survival, sustainability, growth, and profitability of Financial institutions. Several studies have found that a bank’s liquidity condition has a significant impact on its performance.

Other research, on the other hand, has found the opposite. It’s against the backdrop of the fact that there are only a few focal studies on this topic. topic matter, the unsatisfactory results of comprehensive studies that evaluate the impact of liquidity (among other variables) on bank profitability, and the stable liquidity among Cameroon financial institutions, a more focused study measuring liquidity (in isolation) and utilizing more recent data be done to provide more definite proof.

For a financial institution to remain competitive and liquid, it must pay attention to liquidity management and performance with regards to how its ability to manage financial performance can contribute to its organizational achievement. Liquidity management is the ability of a business to meet its cash obligations at a stipulated time period, liquidity plays a big role in determining the success or failure of a firm in business performance due to its effect on it firm’s profitability.

According to Mashoko (2020), the issue of liquidity management and Financial institution performance has been a called for concern in the banking sector, Financial institutions absorbing financial surpluses from their customers (depositors) and put them at the disposal of investors (borrowers) to be directed towards various investment channels.

This investment activity carried out by the bank goes with risks and problems, because the bank is seeking to maximize its expected profits on these investments, and this requires optimum utilization of the available resources, since the bank is exposed at any moment to meet the obligations of its clients and depositors who want to withdraw their savings, and so the bank should be ready to meet these demands at any time.

The problem comes when the Bank is not able to meet these demands, especially those unexpected ones, which may embarrass the bank with its clients and may lose their trust over time, in light of the intensive competition in the banking sector resulting from the increasing number of local banks, as well as intense competition from the foreign banks that work in the local banking market.

One of the last options a bank can ever think of is running to the central bank for a loan (Alshatti, 2015). Nonetheless, these loans are always with high-interest rates.  It is for these reasons that it is necessary to study the effect of liquidity management on the performance of Financial institutions in Cameroon.

1.3 Research Questions

The research questions for this study are as follows

1.3.1 Main Research Questions

What are the effects of liquidity management on the performance of commercial banks in the Fako Division, case of BICEC Bank

1.3.2 Specific Questions

In line with this, the following sub–research questions will contribute to getting an answer to the main research question.

What is the effect does cash reserves ratio, loan to deposit ratio, debt to equity ratio have on the performance of Fako Division, case of BICEC Bank?

1.4. Research objectives

1.4.1 Main objective

To investigate the effects of liquidity management on the financial performance of commercial banks in the Fako Division, the case of BICEC Bank

1.4.2 Specific objectives

1. To evaluate the effect of cash reserve ratio, loan to deposit ratio, and liquidity coverage ratio on the financial performance of BICEC Cameroon
2. To make recommendations based on the findings of this study

1.5 Hypotheses

According to our research questions and objectives we have derived three hypotheses that will be measured using the null form and alternative.

H0: cash reserve ratio, loan to deposit ratio, and liquidity coverage ratio do not have an effect on the financial performance of BICEC Cameroon.

H1:  cash reserve ratio, loan to deposit ratio and liquidity coverage ratio have an effect on the financial performance of BICEC Cameroon