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Journal for Studies in Management and Planning

Available at

http://edupediapublications.org/journals/index.php/JSMaP/

ISSN: 2395-0463

Volume 04 Issue

08

August 2018

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 51

Liquidity Management and Deposit Money Banks’ Performance in Nigeria

BY

ONUORAH, A.C. (Ph.D)

DEPARTMENT OF ACCOUNTING, BANKING AND FINANCE

FACULTY OF MANAGEMENT SCIENCES

DELTA STATE UNIVERSITY, ABRAKA

DELTA STATE

anastasiaonuorah@yahoo.com

Abstract

This research seeks to examine the effect of liquidity management on deposit money banks in

Nigeria. The study spanned from 2000-2017 which is 18 years study. The independent variables used

for the study are liquidity ratio (LR), cash reserve ratio (CRR), loan –to-deposit ratio, and debt ratio

(DR) while the dependent variable is returns on equity. Time series data were used and gotten from

annual reports of the banks under study and Central Bank of Nigeria Statistical Bulletin 2017. The

result revealed that the p-value of liquidity ratio (LR) is 0.0000, cash reserves ratio (CRR) is 0.000,

loan-to-deposit ratio (LDR) 0.000, debt ratio (DR) 0.008. The result shows that all the independent

variables have significant impact on returns on equity on deposit money banks in Nigeria because

their p-values are all less than 5% significant level. The study therefore concluded that the

Granger causality test shows evidence of a uni-directional relationship among all the

variables. Arising from the above, the study therefore recommended that there is need for

banks to engage competent and qualified personnel. The right personnel will ensure that the

right decisions are made especially with the optimal level of cash to keep available for

running the business. And also deposit money banks should be reasonable enough to adopt

other measures of meeting such requirements, which can include borrowing and discounting

bills.

Keywords: Liquidity ratio, Loan-to-deposit ratio, Cash reserve ratio, Debt ratio, Liquidity

Introduction

Liquidity management is an aspect of bank management and it is the ability of a bank to meet

demand deposit. It involves the demand and supply of funds by ensuring that banks maintain

sufficient liquidity to satisfy their customer demand for loans in order to maximize profit and

maintain high level of liquidity to guarantee safety, reach the highest level of owner’s

networth joined with the accomplishment of other corporate objectives.

In Edem, (2017), it was stated that during the banking crisis in 2009 many banks operated

out of liquidity, some survived by raising funds at a large discount rate in order to catch up

with high pressure of demand for urgent cash. During that period, some banks assets were

devalued which made them not to meet up with their banks demand. This influenced the

bank’s ability in stimulating productive economy evidenced in gradual falling in real Gross

Domestic Product. This is why liquidity issues have always been a concern of all the nation’s

stakeholders across the globe, because no sector of the economy can succeed without

sufficient funds. The Central Bank of Nigeria, over the years, precisely since 1958, has

formulated excellent policy thrusts to revamp the Nigerian financial system for sustainable

economic growth. The policy that was introduced; re-capitalisation, merger and acquisition,

consolidation all aimed at strengthening the financial system with little or no emphasis on

liquidity management efficiency. For example, Basel II was recently reviewed to provide for

more capital buffer to hedge bank flimsiness as well as a common measure of operational

risk. These were constituted for business organizations like banks to maximize profit, striking

Page 2 of 16

Journal for Studies in Management and Planning

Available at

http://edupediapublications.org/journals/index.php/JSMaP/

ISSN: 2395-0463

Volume 04 Issue

08

August 2018

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 52

a balance between liquidity and bank return. It has been observed that many approaches

have evolved over the years to measure bank performance such as the use of du-pont ratio,

return on investment (ROI) and return on equity (ROE). These performance measures are

essential empirical information to achieve results. Although, all these regulations put in place

could not improve on the financial system operations of liquidity shocks and standardization.

The study therefore was conducted to bridge the gap in existing literature.

Review of Related Literature

Concept of Liquidity

Inefficient management of liquidity results in serious impairment of banking functions and

contagious effect on the economy. Nwaezeaku (2016) said that a bank is said to be liquid if it

stores sufficient liquid assets and cash together with the ability to raise fund quickly from

other sources to enable it to meet its payment obligations and financial commitments in a

short period.

Components of Liquidity

It is imperative for banks to have adequate and sufficient proportions of these liquid

components as it helps mitigate funding risk, compensation for the non-receipt of inflow of

funds if the borrower(s) fail to meet their commitments, and risk arising from calls to honour

maturing obligations (Nwankwo, 2012). Inadequate liquidity culminates in the compulsion to

liquidate assets at unfavourable prices which could instigate losses. Liquidity shortfalls also

erode customers’ confidence, leading to bank runs which could expose the bank to

unnecessary borrowing from the Central Bank at which eventually subjects the bank to

heightened scrutiny (Osiegbu, Onuorah and Nwakanma 2013). In same vein,

Kurotamunobaraomi (2016) posited that liquidity is the capacity to exchange an asset at a

negligible cost, price and (on) short notice. Jinghan (2012) asserts that banks need a high

level of liquidity in their assets portfolio.

According to Olagunju, Adeyanju and Olabode (2013), liquidity of bank consists of the

following: Call Money in Nigeria, Inter-bank Placement, Placement with Discount Houses,

Treasury Bills, Treasury Certificates, Discounted Bills Payable in Nigeria, Negotiable

Certificates of Deposits, Commercial Papers and Bankers Acceptances, Investments in FGN

Development Stock and Industrial (Other) Investments / long term instruments.

Efficient liquidity management is dependent on features specific to individual bank’s size,

nature and structure as well as the type, extent and complexity of its product. These include:

i) ensuring solvency at all times for settlement of all cash outflow commitments

(both on- and off-balance sheet) on an ongoing daily basis;

ii) ensuing that funding is minimum, by avoiding raising fund at market premiums or

via the forced sale of assets;

iii) ensuring compliance with the statutory liquidity and reserve requirements through

development of adequate management information system and internal control;

iv) optimising the refinancing structure and coordinating issuance of own

instruments in the money and capital markets; and

v) optimising intra-group cashflows such as liquidity “pooling” to reduce

dependency on external refinancing.

Sources of Liquidity

Financial institutions have increasingly funded loan growth not only by reducing their level

of highly liquid investments, but also by seeking alternative funding sources. Funding

theories classify sources of liquidity into two namely: Stored liquidity and Purchased

liquidity. The deposit money banks fund their operations through the following means:

Page 3 of 16

Journal for Studies in Management and Planning

Available at

http://edupediapublications.org/journals/index.php/JSMaP/

ISSN: 2395-0463

Volume 04 Issue

08

August 2018

Available online: http://edupediapublications.org/journals/index.php/JSMaP/ P a g e | 53

(a) Asset-based sources: This is a source in which funds are temporarily invested or stored

with the hope that they would either mature when liquidity is needed or be sellable without

loss in advance of maturity.

Stored liquidity theory is based on three asset liquidity theories – liquid asset, real bill

doctrine and shiftability theories of liquidity management (Nzotta, 2012). The liquid assets

include cash and balances due to other banks, call balance with CBN, balance with other

banks at local and foreign, call money funds, short term government securities such as

treasury bills, treasury certificates and government bonds near maturity within three years;

commercial paper, certificate of deposit and other marketable securities e.g. local and state

securities.

(b) Liability-based sources: This is also called purchased liquidity. Bank liabilities include

all sources of funds acquired and the main sources of bank funds are (i) deposit accounts (ii)

borrowed funds and (iii) long term funds. For example banks receive from large depositors

and also borrow from the big investment banks in order to utilise their investment

opportunities. The funds are pooled together and then allocated to various earning and non- earning assets as appropriate. Including borrowing from CBN through discount or advances,

call money held for other banks, certificate of deposits, and other liabilities like large time

deposits of local and state government and pension funds etc. Liability funding theory holds

that funds can be purchased from the market at a price and used for profitable investment

e.g. lending and other investment.

Such markets include inter-bank market in which the excess fund in the counterparty’s bank

can be lent to members at a cost.25 to 1.00. However, easiness of this transaction depends on

the credit worthiness of the borrowing bank and the economic condition. It is the private last

resort for liquidity funding. Other markets include money and capital markets. This is the

largest source of liquidity. It is a market for wholesale of financial assets. Commercial

papers of varied ratings are sold. In this market pre-maturity assets are also liquidated.

(c) Off balance sheet sources: Kashyap, Rajan, and Stein (2012) posit that banks may also

create important liquidity off the balance sheet via loan commitments and similar claims to

liquid funds. This source has become very important in the management and analysis of

liquidity. Depending on the transaction and level of interest rate at the period, off balance

sheet activities can either increase cash inflow or outflow. For instance, interest rate risk

debt can be hedged through an interest rate exchange arrangement with a highly rated

investment bank. If a fixed rate is higher than the floating rate, the bank receives payment for

the difference between the two rates and vice-versa. Hence the cash flow from the derivative

portfolio aids in the ascertainment of liquidity. The modern theory of financial intermediation

shows bank as playing liquidity creation role, by transforming of short term deposits into

long term investment. By investing in illiquid loans and financing them with demandable

deposits, banks can be described as pools of liquidity in order to provide households with

coverage against consumption shocks.

Measurement of Variable

As mentioned before there are several benefits from having an effective liquidity management

strategy but there are also some severe implications of misjudging the firms liquidity needs

such as risk of bankruptcy (Richards & Laughlin, 2010). There are several measures for

corporate liquidity and different ratios are more important for different stakeholders. Also

from which perspective one is examining the company’s liquidity levels affects the use of

different measurements. Some of the ratios are more interesting for the bank than investors

and accounting measures of liquidity adds another new perspective of the liquidity. Previous