ABSTRACT

This study investigates the relationship between liquidity and profitability management of Deposit Money Banks (DMBs) in Nigeria. The study examined the liquidity-profitability trade-off of ten DMBs using panel least squares regression. The empirical result revealed that there is statistically significant relationship between bank liquidity management and profitability as measured by return on asset and return on equity. Besides, there is significant inverse relationship between cash to deposit ratio and profitability which is an indication of the danger of excessive on the survival of DMBs. The study recommends the need for an optimum utilization of the available liquidity in various investments outlets in order to increase.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The failure of banks on a global scale has been linked to liquidity and profitability crisis, which, in turn, have led to bank runs. This means that there could be a significant link between liquidity and profitability management and bank’s financial performance. Banks requires strong liquidity management competencies to continue playing essential intermediation roles in the financial system and enjoy a positive return on their investment (Nwankwo 2014). The liquidity managerial skill is very important because there is always a trade-off between liquidity and profitability (Sufian & Habibullah, 2010). Profitability would fall if banks were to tie down excess liquidity that could have been profitably invested (Bernanke & Blinder, 2008). That means, there is a need to maintain a balance that results neither in liquidity distresses nor in poor profitability.

Strong liquidity management procedures can improve the reputation of banking firms, which can translate into higher equity returns. It can also suggest to investors that the bank is strong enough to withstand any potential forms of distress. Thus, having a strong liquidity standing can mitigate the risk of bank runs, which usually occur when depositors perceive banks as approaching liquidity crises. Effective liquidity management also has market-related benefits.

Investors account for a bank’s liquidity management skills when considering the firm’s stock price in the capital market. Moreover, investors judge the viability and riskiness of investing in a bank by examining bank’s liquidity standing. This also suggests that banks that must fulfill their liquidity obligations must be able to harness their current assets to balance them against current liabilities. Balancing liquidity is important because it helps to mitigate financial strain and negative working capital. When there is an imbalance between these two factors, liquidity disequilibrium occurs. Such excess or shortage of liquidity supply can adversely affect bank operations, which, in turn, may lead to poor key performance ratios (Janglani and Sandhar, 2013).Almeida and Campello (2002) highlighted that good liquidity management entails having  access to capital markets, which positively bears future investment returns for the firms. In their theory, they highlight that the price paid for cash shortage is greater for banks with large investment opportunities. Some losses are always expected to follow from not being able to take up profitable investment opportunities.

A firm that manages its liquidity well can always capitalize on their balanced liquidity to make viable investments through discounted and lower interest rates in the market. There is no doubt, however, that the market will discount firm’s stock prices if bank’s liquidity management is adjudged poor. Therefore, it is reasonable that deposit money banks (DMBs) liquidity management strategies have continued to draw attention both locally and internationally. Hence, there is a relationship between cash holding management, investment opportunities, and financial performance. Despite this, most of the empirical evidence on the dimensions of the effect of liquidity management measurements (and other important driving factors) differs across countries and times (Alshatti, 2015). Sometimes such adequacy ratio benchmarks that proxy liquidity management are influenced by regulations. For instance, minimum legal reserve requirements may increase or decrease with time and as new regulations are introduced. In developing countries, where most of the banking policies are politicized and subject to political capture, there is much inconsistency in banking practices. Indeed, the inauguration of a new central bank governor might lead to either a decrease or increase in liquidity quality benchmarks.

In 2004, banks received an ultimatum to either merge or recapitalize in order to enhance their efficiency and liquidity status. This recapitalization regulation led the merger of 89 banks into 24. However, with the emergence of a new apex bank governor, the idea of bank mergers was considered hazardous to the banks efficient liquidity utilization, especially regarding credit distribution. In addition, in times of global economic or financial crises, the liquidity adequacy threshold could change, thus rendering prior evidence irrelevant to present economic policies. Moreover, the most important factor that has caused variations in results, and a factor that has largely been overlooked in previous literature, is the firm’s performance measurement. While some scholars use accounting measures such as return on assets (ROA) (Hassan and Bashir, 2016), others consider measures based on a market perspective, such as return on equity (ROE). According to Yasser, (2011) and Tobin’s Q. Shah (2011). Rivard and Thomas (2012) suggested that bank profitability is best measured by ROA because, unlike ROE, ROA is not distorted by high equity multipliers. In addition, they argue that ROA is the best measure because it represents a more accurate measure of the ability of a firm to generate returns on its portfolio of assets. In addition, ROA gives an idea of how skilled the management team of the firm is at utilizing its assets to generate earnings. However, critics have suggested that the use of accounting figures such as ROA usually led to model misspecifications. The reason for this is that most accounting figures are subject to management bias and manipulation. Thus, such figures do not always accurately reflect corporate operations. As such, they are prone to estimation error, which results in misinterpretation and misapplication on the part of investors.

According to Pimental (2009), liquidity can be defined as the final measure of economic success achieved by a company in relation to the capital invested in it. This economic success is determined by the magnitude of the profit. Liquidity is the company’s capacity to liquidate maturing short-term debt within a year. Maintaining adequate liquidity is much more than a corporate goal is a condition without which it could not be reached the continuity of business. Put differently, bank liquidity means banks having money when they need it particularly to satisfy the withdrawal needs of their customers.

The survival of deposit money banks depends greatly on how liquid they are since liquidity being a sign of imminent distress can easily erode the confidence of the public in the banking system and results to run on deposit. Profitability according to Heibata, Nourani and Dadkhah (2009), a business is organic, it survives and grows, and therefore, it is important that a bank earns profit for its long-term survival must be earned to maintain the activities of the business to be able to obtain funds for expansion and growth of the bank.

However, according to the trade-off theory, higher liquidity may also reduce the banks risks and hence premium demanded to compensate investors for the costs of bankruptcy. (Osborne et al, 2012). Furthermore, since bank’s optimal liquidity level is likely to vary over the business cycle, typically rising expected loss of distress, the relationship between liquidity and profitability is likely to be highly cyclical becoming more positive during the periods of distress its banks that increase their liquidity improve their profitability (Osborne et al., 2009).

Agbada and Osudi (2003) captured the relationship between liquidity and profitability. According to the authors, maximum safety or liquidity can be attained only if the banks keep high amount of cash against deposit they hold. But if they keep investing and trying to increase the profitability factor then they will have illiquidity problem if customers demand for much cash in a given period a bank with higher liquidity level has more chances of surviving and improving profitability in the future.

First Bank was incorporated as a limited liability company in March 1894 and was listed on the Nigeria stock exchange in March 1971. First bank is one of the oldest financial institutions in Nigeria and was the first bank to be established in West Africa. Also, in addition, the bank is a leading member of the ATM consortium (an off-side independent ATM service provider) as well as member of payment processing limited an electronic transaction switching and payment processing company. In 2021, First Bank Plc. became First Bank Limited.

Finally, many studies on liquidity and profitability management neglected the operating performance variables as proxies of performance, this study seeks to employ the variable to investigate how deposit money banks can manage two objectives of liquidity and profitability which tends to work in opposite direction.

1.2 Statement of the Study

The latest evidence of the effect of liquidity and profitability management on the performance of banking firms in Nigeria is not yet established. Following a multi-performance approach of banks, there is need to examine the effect of liquidity and profitability management by using several bank performance indicators to detect the level the two main objectives as managed by the deposit money banks. This will identify which performance indicators should be most strongly considered to make an informed decision, which, in turn, would mitigate consistent bank failures in Nigeria. Liquidity management involves putting into circulation an amount of liquidity in accordance with the expected level of short-term reserve money without distorting the operations of such corporate firms. It also involves strategically adhering to regulatory cash reserve requirements. Profitability in the other hand involves making good profit to cover expenses and guarantee returns to financiers and owners. Deposit money banks in Nigeria to have performance challenges in terms of liquidity and profitability unless these two objectives are properly managed. Studies in advanced countries have showed that poor liquidity and profitability management have disastrous consequences on financial institution at detriment of maintaining liquidity can be disastrous to profitability leading to the winding-up of the bank. Therefore, it is necessary in this study examine how Nigerian deposit money bank can efficiently manage its liquidity and profitability to achieve good performance.

1.3 Objectives of the Study

The main aim of objectives of this study is to examine the liquidity and profitability management in First Bank of Nigeria Limited as a case study. The specific objectives of the study include;

1. To examine the relationship between liquidity and profitability management in the deposit money bank in First Bank of Nigeria Plc.
2. To study the importance of liquidity and profitability management in deposit money banks
3. To find out factors influencing liquidity and profitability management in the deposit money bank in Nigeria.
4. To access the possible ways of improving and managing liquidity and profitability in the deposit money banks.

1.4 Research Questions

1. What is the relationship between liquidity and profitability management in the deposit money bank in Nigeria?
2. What are the importance of liquidity and profitability management in the deposit money banks?
3. What are the factors influencing liquidity and profitability management in the deposit money bank in Nigeria?
4. What are the possible ways of improving and managing liquidity and profitability in the deposit money banks?

1.5 Significance of the Study

The research work would provide critical basis for Nigerian Bank Management/Managers

On the need of liquidity and profitability management in deposit money bank. It would be of benefit to management in strengthening their liquidity and profitability management. Lastly the project would be of great importance to the researchers, who have interest in further research under-taking in this study as this project will aid as a good research material.

1.6 Scope and Limitations of the study

This research project aims on the relationship which exist between liquidity and profitability management and financial position of banks, it focuses on First Bank of Nigeria Plc, Ikot Ekpene Branch Akwa Ibom State, as an examination material at the ND level it’s volume which does not allow for extensive coverage is restricted to about 40 – 50 pages. Moreover, the very limited time allowed financial constraints, poor attitude of some bank executive towards provision of information have combined to further restrict the covered.

1.7 Organization of the Study

The Research work is organized into five chapters. Chapter on focuses on Background of the study, research Question, Significance of the study, Scope and limitations of the study, organization of the study and definition of terms.

Chapter two deals with the review of related literature. It reviews in a theoretical framework, the work written by the scholars.

Chapter three presents research methodology which is made up of introduction, the design of the study, area of the study, population of the study, sample and sampling techniques, method of data collection and data analysis techniques.

Chapter four deals with data presentation, analysis and interpretation and chapter five focuses on findings, conclusion and recommendations.

1.8 Operational Definition of Terms

Liquidity: can be defined as a measure of the relative amount of asset in cash or which can be quickly converted into cash without any loss in value available to meet short terms liabilities.

Profitability: is a situation where the income generated during a given period exceeds the expenses incurred over the same length or time for the sole purpose of generating income.

Solvency: is described as the ability for a corporation to meet long-term fixed expenses and to accomplish long term expansion and growth.

Management: Is the process of reaching organizational goal by working with and through people and other organizational resources.

Investors: These are people who allocate their capital into the business with the expectation of a future financial return.

Bankruptcy: Is defined as a situation in which a person or the entity cannot repay the debts it owes at a reasonable time.

Liquidity and Profitability Management: It is all about managing the current assets and current liabilities in such a way that profitability will be optimum and the business not lacking liquid funds.

Deposit Money Bank (DMB): It is a financial institution licensed by the regulatory authority to mobilize deposits from the surplus unit and channel the funds through loans to the deficit unit and performs other financial services activities.

Financial Institution: This is an establishment that completes and facilitates monetary transactions. It is also a place where consumers can effectively manage earnings and develop financial footing.