The Effects of Liquidity Management On The Financial Performance Of Commercial Banks

CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND OF STUDY

In every system, there are major components that feature paramount for the survival of the system. This is also applicable to the financial system. The banking institution had contributed significantly to the effectiveness of the entire financial system as they offer an efficient institutional mechanism through which resources can be mobilized and directed from less essential uses to more productive investments (Wilner,2000).

In the performance of this financial inter-mediation role, the financial institutions have proved to be an effective channel between savers and borrowers. Among the financial institutions that make themselves available for this all-important role are merchant banks, savings banks, the Central bank, development banks and commercial banks. Commercial banks have overtime become very important institutions in the financial system as they function as retail banking units facilitating the transfer of financial assets that are well desired from some part of the public (Fund Lenders) into other financial assets which are more widely preferred by greater part of the public (fund seekers). In view of this role and of the fact that the activities of the commercial banks affect the greater part of the society, commercial banks are selected as the main focus of this study.

Financial inter-mediation role of the commercial banks hence becomes the bed-rock of the two major functions of commercial banks namely deposit mobilization and credit extension. An adequate financial intermediation requires the purposeful attention of the bank management to profitability and liquidity, which are two conflicting goals of the commercial banks. These goals are parallel in the sense that an attempt for a bank to achieve higher profitability will certainly erode its liquidity and solvency positions and vice versa.

Practically, profitability and liquidity are effective indicators of the corporate health and performance of not only the commercial banks (Eljelly,2004), but all profit-oriented ventures. These performance indicators are very important to the shareholders and depositors who are major publics of a bank. As the shareholders are interested in the profitability level, the depositors are concerned with liquidity position which determines a bank’s ability to respond to the withdrawal needs which are normally on demand or on a short notice as the case may be.

Liquidity management is an important aspect of monetary policy implementation, while the other integral component of monetary policy, i.e. economic management, involves promoting sustainable economic growth over the long term by keeping monetary and credit expansion in step with an economy’s noninflationary output potential, liquidity or reserve management as a shorter time horizon. In order to maintain relative macro-economic stability, reliance is placed on liquidity management to even out the swings in liquidity growth in the banking system.

An important step towards market oriented policy procedures takes place when the Central bank assumes responsibility for evening out swings in demand relative to demand on its own initiative, rather than waiting passively for individual banks to come to it. Once it begins to supply or absorb liquidity through market intervention, the discount window plays an important, but subordinate safety valve role by providing the short-run reserve needs of the banking system for purposes of meeting short term liquidity obligations.

In the financial intermediation process, a bank collects money on deposit from one group (the surplus unit) and grants it out to another group (the deficit unit). These roles involve bringing together people who have money and those who need money.

Apart from the technical aspects of the CBN’s responsibility discussed above, it is important in this section to highlight certain critical factors that are required to facilitate liquidity management in the context of autonomy. These include a stable macroeconomic environment, a sound and competitive financial system, adequate regulatory and supervisory framework, and capacity build up.

Stable Macroeconomic Environment to enhance liquidity management and ensure macroeconomic stability, there is the compelling need to insulate monetary policy from the pressure of financing the government fiscal deficit. Also, the monetary authorities should have freedom in the management of interest rate in order to sufficiently influence transactions in the intervention securities and enhance the effectiveness of instruments for liquidity management. Uncontrolled financing of the deficit by the CBN, either through ways and means advances or the absorption of unsubscribed government debt issues, increase bank liquidity thereby constraining the effectiveness of instruments for liquidity management (Amarachukwu Ona, 2003)

Under the new dispensation, sustaining monetary stability will be achieved through greater coordination between the CBN and the Federal Ministry of Finance, in order to limit government borrowing from the bank to the level stipulated by law.

1.2       STATEMENT OF THE PROBLEM

The issue of liquidity for commercial banks is very vital to the existence of any organization, ECOBANK inclusive. However, illiquidity of commercial banks especially the banks can lead to loss of businesses thereby reducing the potentials of earnings and profitability. This is because high liquidity position of bank helps it to meet up with obligations such as funding of loans and advances that could aid the bank to earn income in the form of interests and loans.

In the light of this, scholars have argued for and against liquidity as being critical in banks’ life and profitability. Some scholars such as Duru and Ekwe(2013), argue found out that commercial banks that maintain high liquidity earn high profitability. However, other authors argue that liquidity does not positively affect profitability. In other words for sustainable intermediation function, banks need to be profitable. Beyond the intermediation function, the financial performance of banks has critical implications for economic growth of countries. Good financial performance rewards the shareholders for their investment. This, in turn, encourages additional investment and brings about economic growth. On the other hand, poor banking performance can lead to banking failure and crisis which have negative repercussions on the economic growth, Ongore and Kusa (2013).

Liquidity problems may adversely affect the financial performance of a bank as well as its solvency. Some studies have shown a significant positive relationship between bank profits and liquidity while others have shown a weak positive relationship. ECOBANK in Cameroon registered strong performance in 2013, exceeding the overall country economic growth. The banking sector in Cameroon was rated strong in 2013 using the capital adequacy, asset quality, management quality, earnings and liquidity rating system (Banking Supervision Report, 2013).

Although, studies have it that lack of adequate liquidity in a bank is often characterized by the inability to meet daily financial obligations. At time it may have the risk of losing deposits which erodes its supply of cash and thus forces the institution into disposal of its more liquid assets. As opined by Pandy (2015), managing monies of a bank in order to maximized cash availability and interest income on any idle cash is a function of liquidity management. However, the problems of weak corporate governance, poor capital base, illiquidity and insolvency, poor asset quality and low earnings are some of the constraints faced by the banking sector in Cameroon.

Some worked by Johnson (2008) examined the differences in financial ratio averages between industries. The results showed that liquidity management has no effect on the bank’s profitability. Moreover, Kweri (2011) examined the same problem among manufacturing banks. There is little study done so far on the effect of liquidity management on the performance of commercial banks in Cameroon. It is the light of this, that this study has evaluated the effect of liquidity management on the financial performance of commercial banks in Cameroon.

1.3       RESEARCH QUESTIONS

The study is intended to answer the following research questions as listed below:

i). Is there a significant relationship between liquidity management and profitability of commercial banks in Cameroon?

ii). Does the amount of loans and advances granted to customers significantly determine the profitability level of the bank?

iii). Does liquidity necessarily affect the investment portfolio performance of the bank?

1.4 OBJECTIVES OF THE STUDY

1.4.1 Main Objective

The main objective of this study is to know the effect of liquidity management on the financial performance of commercial banks in Cameroon Case study of ECOBANK. The study also seeks to determine the quality of liquidity management employed by ECOBANK Cameroon

The research design used for this study is a descriptive research design which focuses on describing information collected from the field. The target population for this study was ECOBANK Cameroon. The sample size consisted of employees of ECOBANK, they were selected through purposive sampling technique.

The data analysis method adopted for this study was simple descriptive statistics and multiple regression analysis.

1.4.2 SPECIFIC OBJECTIVES

1. i) This study seeks to establish the effects of liquidity management on the performance of commercial banks in Cameroon.
2. ii) The study is aimed at discovering the specific factors that are useful in enhancing the profitability and liquidity position of the commercial banks.

iii) The study equally examines and identifies the basic causes of liquidity problems in Cameroonian’s commercial banks and to recommend appropriate measures to solve such problems.