LIQUIDITY MANAGEMENT ON THE PERFORMANCE OF COMMERCIAL BANKS IN NIGERIA

1.1 Background to the Study

Liquidity management in banks has posed several challenges during the distress era of 1980s and 1990s and persisted to the re-capitalization phase in 2005 when banks were mandated to have an increased capital base from N2 billion to an astronomical N25 billion (Agbada & Osuji, 2013). The apex bank’s mandate for recapitalization was considered to be the salvation for the banking and indeed financial system in Nigeria, however, just five years later, precisely 2009, the Central Bank’s intervention was sought to stabilize and redeem five banks that were deeply enmeshed in illiquidity. Consequently, N620billion was injected into the five affected banks to stimulate stability, and confidence and subsequently heralded the establishment of Asset Management Corporation of Nigeria (AMCON) for the acquisition of affected banks.

Adequate liquidity is a sine qua non of banking. The significance of adequate liquidity lies in the fact that a bank can live for some time with an inadequate capital or an interest rate gamble that has gone sour, but cannot survive even in the short run without liquidity. Banks must therefore ensure the maintenance of commensurate part of its assets in cash and/or in liquid assets that can be easily converted to cash for it to remain in the business of banking, taking into cognizance the conflict between the maintenance of adequate liquidity and banks profitability (Nwankwo, 2014).

Several liquidity management strategies have evolved in the Nigerian banking industry. These measures either originate from the regulatory and monetary authorities or ones adopted by banks in order to meet matured obligations, take advantage of profitable opportunities in the market and sustain existing public confidence.

Management and maintenance of adequate liquidity enables a bank to meet commitments when due and to undertake new transactions when desirable. Most times, these liquidity management measures or strategies include reserve requirement by CBN, cash and balances due to other banks, short-term securities etc. It is expected that given some of the liquidity management strategies, the issue of liquidity crisis in the Nigerian Banking industry will become a thing of the past but the reverse is the case. Liquidity crises seem to have gained momentum and have taken center stage of national discussions.

Ndugbu (2013) noted the recent experience from the global financial crisis that led to the collapse of many world-renowned financial institutions and even caused an entire nation to be rendered bankrupt. According to him, specifically in Nigeria, many of the banks sustained huge losses and had to be rescued through capital and liquidity injections by the Central Bank of Nigeria.

Liquidity is the ability of a deposit money bank to pay its short-term obligations to its depositors and creditors. Liquidity ratios are broadly classified into Current Ratio, Liquid ratio, and Net working capital ratio. It is used to ascertain how liquid a firm is and its potentials in meeting maturing short term obligations (Umobong, 2015). On the other hand, profitability is the measure of the difference between the bank’s operating expenses and income. Liquidity and profitability can be likened to two centrifugal forces with contradictory objectives which at all times threaten to pull the bank apart. This dilemma is not peculiar only to deposit money banks in Nigeria (Eljelly, 2014).

Profitability and liquidity as performance indicators are very important to all stakeholders: 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 may be. The tax authorities are interested in the profitability of the banks in order to determine the appropriate tax obligation and size (Olagunji et al., 2011).

The profits of deposit money banks are primarily from interest on their assets, such as loans and investment even cash. However, most of their liabilities are deposits payable practically on demand. For that reason, managing healthy liquidity level while at the same time maximizing profit becomes central issues in banking. The contradictory nature of liquidity and profitability can be explained by the intuitive reasoning that a bank operating with high liquidity (and in the process tying down investable funds) may have a low insolvency risk, but with a trade-off of low profitability. Conversely, a bank operating at a low liquidity level (and thus freeing investible funds) may face high insolvency risk, but with a tradeoff of higher profitability.

According to Charumathi (2008), banks are always aiming at maximizing profitability while at the same time trying to ensure sufficient liquidity. In order to achieve these contradictory objectives, it is essential that banks have to monitor, maintain and manage their assets and liabilities portfolios in a systematic manner taking into account the various risk involved in these areas like the interest rate risk, operation risk and gap analysis. The risk of illiquidity may increase if principal and interest cash flows related to assets, liabilities and off-balance sheet items are mismatched. Managing liquidity is a fundamental component in the safe and sound management of all financial institutions. Sound liquidity management involves prudentially managing assets and liabilities, minding both the cash flow and concentration in order to ensure that cash inflows have an appropriate relationship to cash outflows. This needs to be supported by a process of liquidity planning which assesses potential future liquidity needs, taking into account changes in economic, regulatory or other operating conditions. In Nigerian, in the light of the intensive competition in the banking sector resulting from the increasing number of local banks, as well as the re-entrant of foreign banks, the operating environment is so competitive and tense that any deposit money bank that hopes to survive must ensure an astute management of its profitability viz-a-viz its liquidity level as both variables can make or mar its future. The challenges of inefficient liquidity management of banks in Nigeria were brought to the fore during the liquidation and distress era of the late 1980s and early 1990s. The negative cumulative effects of the banking system liquidity crisis from the 1980s and 1990s lingered up to the re-capitalization era in 2005 in which banks were mandated by CBN to increase their capital base from N2 billion to an astronomical N25 billion. This move was believed would be able to stabilize and rectify the bank liquidity problem that was prevalent in the economy (Fadare, 2011).

In order to avoid liquidity crisis, the management of businesses and financial institutions in particular needs to have a well-defined policy and established procedures for measuring, monitoring, and managing liquidity. Managing liquidity is therefore a core daily process requiring managers to monitor and project cash flows to ensure that adequate liquidity is maintained at all times (Berger &Bouwman, 2018). Accordingly, the study seeks to determine the effects of liquidity management on the financial

performance of banks in Nigeria.

1.2 Statement of the Problem

The operational activities carried out by banks are hardly devoid of risks and problems, because the bank is seeking to maximize its expected profits. This requires optimum utilization of the available resources. Since the banks are expected at any moment to meet the obligations of its clients and depositors who want to borrow or withdraw their savings, the problem arises when the Bank is not able to meet these obligations especially those unexpected ones. This may cause embarrassment for the bank. Its clients may lose their trust and confidence leading to bank run. Therefore, as each commercial bank tries to maximize its profits, it must also be able to meet the financial obligations of its depositors by holding a sufficient amount of liquidity. In order to achieve this delicate balance between the profitability and liquidity, Banks should determine the optimal amount of cash that will enable them to achieve the balance between profitability and liquidity together, because each level of liquidity has a different effect on the levels of profitability. In Nigeria, most banks are faced with challenges of financial performance. This is seen in the fact that the banks have problems with financial performance they may defer their payments to creditors which is harmful for companies and can result in several consequences such as worse credit terms in the future. This in the long run adversely affects profitability. It is evident that research in the area of liquidity management has not come up with convincing and unanimous result. Manufacturing companies to remain competitive emphasis should be place on liquidity management and performance with regards to how their ability to manage financial performance and should be provided to the organizational achievement. This study will focus on the effect liquidity management on financial performance of banks in Nigeria.

1.3. Objectives of the Study

The main objective of the study is to examine the effect of liquidity management on the performance of commercial banks in Nigeria.

The specific objectives are to:

1. To examine the effect of current ratio, quick ratio and cash ratio on return on asset of commercial banks in Nigeria

2. To estimate the effect of current ratio, quick ratio and cash ratio on return on equity of commercial banks in Nigeria.

3. To examine the effect of current ratio, quick ratio and cash ratio on earnings per share of commercial banks in Nigeria.

LIQUIDITY MANAGEMENT ON THE PERFORMANCE OF COMMERCIAL BANKS IN NIGERIA

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