THE IMPACT OF LIQUIDITY MANAGEMENT ON COMMERCIAL BANK PROFITABILITY

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THE IMPACT OF LIQUIDITY MANAGEMENT ON COMMERCIAL BANK PROFITABILITY

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

In every system, there are major components that are very important for the survival of the system. This is also applicable to the financial system. The financial institution have contributed immensely to the growth of the entire financial system, as they offer an efficient institutional method through which resources can be mobilized and directed from less productive uses to more productive uses.

In performing these financial role, the financial institutions has proved to be an effective link between savers and borrowers, among the financial institutions that have partake in these important financial role are the commercial banks. The functions of the commercial banks have become the strong base for the two major functions of the commercial banks namely deposit mobilization and credit extension. Commercial banks have become a very important institution in the financial system as it helps in facilitating the movement of financial assets that are less desirable to the more desirable public who needed the financial assets. In view of this role and activities commercial banks play in the society, the commercial bank is selected as the main focus of this study.

An adequate financial intermediation requires the attention and focus of the bank management to the profitability and liquidity, which are the two conflicting objectives of the commercial banks. These objectives are parallel in the sense that an attempt for a bank to achieve higher profitability will gradually destroy its liquidity and solvency position and vice versa. Practically, profitability and liquidity are effective indicator of the corporate wealth and performance of not only commercial bank but to all profit oriented venture. These performance indicators are very important to the shareholders and depositors who are major publics of a bank. As the shareholders expect the bank to increase lending in order to give them maximum return in money invested while the depositor expect the bank to keep much idle cash in order to meet their demand. With profitability objective conflicting with that of liquidity, and with the interest of the shareholders conflicting with that of the depositors, there is the need for reconcile and harmonize these conflicting positions through effective liquidity management so as to ensure the survival and growth of the commercial banks.

1.2 STATEMENT OF PROBLEM

Through these financial roles, the commercial banks use the idle funds borrowed from the lenders by investing such funds in other classes of financial assets investment. These business activities of the bank is not done without problem facing it, since these deposit which have been invested by the banks for profit maximization can be demanded for at any time. When the bank is not able to meet their financial obligations, the public begins to loss confidence and these will cause lot of competition to the financial sector. With the high increase of competition in the banking industry, every commercial bank should strive to operate on profit and at the same time meet the financial demand of its depositors by maintaining adequate liquidity. The problem then becomes how to select the optimum point at which commercial bank can maintain its assets in order to optimize these two objectives.

These problems become more difficult as a large number of banks are basically engaged with profit maximization and tend to neglect the importance of liquidity management and these can lead to technical and legal insolvency. This research work will also see to other problems such as the effect of excess liquidity and the problem of estimating the proportion of the deposits that can be demanded for at any specific time, selection of factors that will affect or influence the bank liquidity level and finally problem of satisfying the two major publics of the commercial bank simultaneously. With these solutions will be prescribe and recommendations will be made where necessary.

1.3 OBJECTIVE OF THE STUDY

The competition environment of the financial institutions is to tense that any commercial bank that aims to survive must be aware of the challenges of its liquidity and profitability obligation as both variable can make or destroy its future. This study is largely centered on liquidity objective and ensure its ability to meet up the depositors demand thereby maximizing its value and there is also uncertainties in the asset management of the commercial banks as the new deposit does not correspond with the customers’ withdrawals, since demand is made at short notice. Therefore this study is aimed at the following goals:

– To know how liquidity management will handle these uncertainties and determine their effect on profitability

– Discovering the specific factors that are useful in improving profitability and liquidity position of the commercial banks.

– To examine the cost of liquidity and illiquidity levels on the performance of commercial banks and length at which this liquidity can be used as competitive instruments.

– To take a critical view of the adopted liquidity measures of the commercial banks and attempt to see how it has been achieved.

– Finding out the effect of changes in liquidity levels on profitability.

– Aimed at discovering the credit and portfolio policies of the commercial banks

– Finally it will attempt to identify the basic causes of liquidity problems in Nigeria commercial banks and to recommend appropriate measures to solve such problems.

1.4 RESEARCH QUESTIONS

Based on the study the following research questions are asked:

– What factors can be useful in improving profitability and liquidity position?

– How can liquidity management lead to profitability?

– What will be the effect of changes liquidity levels on profitability?

– Is there any relationship between liquidity level and profitability level?

1.5 HYPOTHESIS

From the statement of problem, objective of study and research questions of the study, the following hypothesis are formulated:

i. Null Hypothesis (Ho): There is no significant relationship between liquidity level and deposit level.

Alternative Hypothesis (HI): There is a significant relationship between liquidity level and deposit level.

ii. Null Hypothesis (HO): The amount of loans and advances granted to customers does not significantly determine the profit level.

Alternative Hypothesis (HI): The amount of loans and advances granted to customers significantly determine the profit level.

iii. Null Hypothesis (HO): There is no significant relationship between liquidity and profitability.

Alternative Hypothesis (HI): There is a significant relationship between liquidity and profitability.

iv. Null Hypothesis (HO): Commercial banks in Nigeria do not keep the minimum liquidity ratio required by the CBN.

Alternative Hypothesis (HI): Commercial Banks in Nigeria keep the minimum liquidity ratio required by CBN.

1.6 SCOPE OF STUDY

This study on the impact of liquidity management on commercial bank profitability is carried out to check the possibility of liquidity management bringing a huge range of profitability to the commercial bank. It uses Oceanic Bank International Plc Effurun Delta State as its scope and it is carryout within 2007 to 2010 that’s a time frame of 4 years.

1.7 THE SIGNIFICANCE OF THE STUDY

For the fact that commercial banks operate on liquidity and profitability motives in the mind to satisfy their major publics, the shareholders and depositors, the need arise for them to bring into agreement these two motives with the aim of satisfying these two public concurrently. With this the commercial bank need effective and efficient liquidity management approaches and principles that will help them realize these motives. The result gotten form this study will reveal the level of attachment of the commercial banks to the monetary policies (liquidity ratios) established by the government and these will help the government to set appropriate liquidity ratio’s and cash ratio’s that will not be harmful to the operation and survival of the commercial banks. It will also help banks operators to evaluate how effective liquidity management and credit policy guidelines will affect profitability level and also the impact bank credit will play on bank’s liquidity and finally minimize the effect of illiquidity and help in providing effective liquidity formulations.

1.8 LIMITATIONS OF STUDY

Like every research work, this study is faced with a large number of challenges, starting from bank executives unwillingness to disclose necessary document and information needed for this study since they felt this information or document are confidential to them and that disclosing them might be detrimental to their business. This study is supposed to cover all commercial banks in Nigeria as they operate a unique policy in view of it threats and opportunities. However, the study is limited to just one particular bank due to insufficient time and lack of finance. Basically, the school activities as such have been a great challenge to this research, since these activities have occupied most time needed for this research. Nevertheless with all these challenges the researcher tried to conduct the research which is reliable.

1.9 Definition of Terms

a) Liquidity: Ability with which asset can be easily converted into cash. It also determines a firm ability to meet its short-term obligation.

b) Liquidity Management: The planning and control necessary to ensure that organisation maintain enough liquid assets so as to meet its obligations to customers.

c. Profitability: Profit is the ultimate measure of overall performance that is the excess of income over cost.

d. Commercial Bank: The business of receiving money, from outside source as deposits, irrespective of payment of interest and granting of money loan and acceptance of credit or purchase and sells of securities for the account of others or incurring of obligations to acquire claims in respect of loans prior to maturity.

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