CHAPTER ONE

INTRODUCTION

1.1 Background of 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 recapitalisation 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.

Alshatti (2015), brought to light the fact that Banks are largely exposed to various types of risks attributable to liquidity management, which affect the performance and activity of these banks. Admonishing that since the primary goal of the banking management is to maximize the shareholders’ wealth, banks should assess the cash flows and the assumed risks in order to direct its financial resources in different areas of utilization. Ibe (2013) emphasizes that Liquidity plays a vital role in the successful functioning of a business firm; a firm should ensure that it does not suffer from lack-of or excess liquidity to meet its short-term compulsions.

Also capacity of banks to perform their intermediation and credit creation roles in a manner that guarantees optimal profitability and minimum risk is greatly hinged on having adequate liquidity. This liquidity – profitability mix provides stability and confidence banks and the financial system in general as it is the panacea for confidence (Ogbuabor & Malaolu, 2013; Okoye & Eze, 2013). Among all core banking principles, liquidity plays a crucial role as it is vital for survival of the banking business especially in risk prone business environments (ECB, 2010), given its capacity to make or mar any institution (Nwankwo, 1989). Little wonder Ibe (2013) opined that firms should identify and maintain optimal liquidity positions to avoid shocks attributable to scarcity or glut of it. A preponderance of research has been conducted to investigate the inter-relationship between liquidity and corporate performance (Raheman & Nasr, 2007; Benjamin & Kamalavali, 2006; Saleem & Raheman, 2011; Bassey & Moses, 2015) albeit, in the developed world. Also, these studies overwhelmingly use Return on Capital Employed (ROCE), Return on Equity (ROE), Return on Investment (ROI), Return on Asset (ROA), Earnings Per Share (EPS), Profitability Index (PI) etc., as measures of corporate performance. Consequently, this study adopts Return on Shareholders’ Fund (RSF) as a measure of corporate performance as it is more encompassing and efficient in comparison with the others. Also, return on shareholders’ funds is considered important because it is a narrower assessment of profitability when compared with return on capital employed and it therefore reveals to the investor a deeper insight into the profitability of a firm.

Liquidity risk appears when there are differences between the size and maturity of assets and liabilities on the balance sheet. There are generally two types of liquidity risks which are funding liquidity risk and market liquidity risk. Funding liquidity risk is the risk that the bank is not able to respond effectively to current needs as well as future cash needs without affecting its daily operations and financial condition. Market liquidity risk is defined as the risk that a bank cannot easily offset or eliminate a position without significantly affecting the market price (Ferrouhi & Lehadiri, 2014).

Profitability and liquidity as performance indicators are important to the major stakeholders of any firm and banks in particular. 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 maybe. The tax authorities are interested in the profitability of the banks in order to determine the appropriate tax obligation (Olagunji, Adeyanju & Olabode, 2011).

Against the backdrop of the research, the study empirically examines the nature of relationship between liquidity and performance by using Cash Reserve Ratio (CRR), Loan to Deposit Ratio (LDR), Liquidity Ratio (LR) to proxy liquidity and Return on Shareholders’ Fund (RSF) to operationalize performance. This study uses UBA Plc. as a point of reference.

1.1.1 Brief History of UBA PLC.

The origin of UBA dates back to 1949 when it was first referred to as the British and French Bank Limited (BFB). It took over the assets and liabilities of BFB and was incorporated as a limited liability company on 23 February, 1961 under the Companies Ordinance (Cap 37) 1922. UBA was the first Nigerian bank to make an Initial Public Offering (IPO), following its listing on the NSE in1970. It was also the first Nigerian bank to issue Global Depository Receipts (GDRs). In 2005, it completed one of the biggest mergers in the history of Nigeria’s capital markets following the business combination with Standard Trust Bank (STB) Plc. From then, it commenced its pan-African expansion, which has led to its presence in Ghana, Benin Republic, Cote d’Ivoire, Burkina Faso, Guinea, Chad, Cameroon, Kenya, Gabon, Tanzania, Zambia, Uganda, Liberia, Sierra- Leone, Mozambique, Senegal, Congo DR and Congo Brazzaville. It also established presence in France and the UK to complement its already existing USA office.

United Bank for Africa (UBA) Plc. is a leading financial services grouping sub-Saharan Africa with presence in 19 African countries, as well as the United Kingdom, the United States of America and France. It is a publicly quoted company listed on the Nigerian Stock Exchange (NSE) and has a well-diversified shareholder base.

1.2 Statement of problem

In Nigeria and the competitive world, the banking sector has emerged as a key player, contributing its best to create employment, and improving the financial sector of the country. With the current and growing trend in Nigeria economy, it has become a challenge for the sector to create employment and contribute meaningfully to the economy due to inability to earn maximum performance. Therefore, it is necessary for banks to take dynamic decisions to effectively manage their assets, particularly liquidity management in order to bring about the needed improvement in their performance.

Moreover, considering the public loss of confidence as a result of distress which bedeviled the financial sector especially banks in the recent past; and the intensity of competition in the banking sector due to the emergence of new banks, every deposit money bank should ensure that it operates profitably and at the same time meets the financial demands of its depositors by maintaining adequate liquidity (Olagunji, Adeyanju, & Olabode, 2011).

Deposit money banks are often confronted with the problem of how to choose and identify the optimum point or the level at which it can maintain its assets in order to optimize the set objectives (Ajibike & Aremu, 2015). This investigated the effect of liquidity (the proportion of the deposits that may be demanded by the depositors at any particular time) on the performance of banks. This study focuses on UBA Plc.

1.3 Objective of the Study

 Main objective

The main objective of this study is to examine the effect of liquidity on bank’s performance.

 Specific objectives

The specific objectives of this study are given below:

1 To find out the determinants of liquidity risk in UBA Plc.

2 To analyze the impact of liquidity risk on the profitability of UBA Plc.

3 To examine the liquidity position of UBA plc bank.

4 To find out whether liquidity ratio has significant impact on commercial banks operating performance.

1.4 Research questions

The following research questions were drafted by the researcher to serve as guide in executing the study.

1 What are the determinants of liquidity risk in UBA Plc?

2 To analyze the impact of liquidity risk on the profitability of UBA Plc?

3 To examine the liquidity position of UBA plc bank?

4 To find out whether liquidity ratio has significant impact on commercial banks operating performance?

1.5 HYPOTHESIS

Hypothesis I

H0: The dependence on non-deposits affects the liquidity risk of Bank of Baroda

H1: The dependence on non-deposits does not affect the liquidity risk of Bank of Baroda

Hypothesis II

H0: The liquidity risk affects the profitability of Bank of Baroda.

H1: The Liquidity risk does not affect the profitability of Bank of Baroda.

1.6 Significance of the Study

This study would be of immense value to investors, regulators, Managers, academia and other relevant stakeholders. By relating liquidity to performance using lending spread as proxy for profitability, the study would provide future researchers with an alternative measurement area which has little or no research within the Nigerian context. This study evaluated banks’ liquidity position and how it affects their performance.

Various studies on liquidity and bank’s profitability concentrated on macroeconomic factors like Inflation and exchange rate, while a few concentrated on firm level. This study employed firm level data to examine the impact of liquidity on bank performance in Nigeria.

Furthermore, the reports from empirical studies on the subject matter still remain inconclusive. For instance, Ajibike and Aremu (2015) reported positive relationship between liquidity and profitability but, Olanrewaju and Adeyemi (2015) reported no significant relationship, while Eljelly, (2004) and Dahiyat, (2016) concluded that there is negative relationship between liquidity and profitability. The lack of consensus among literatures clearly shows that further study needs to be carried out. Also, this study differs from existing literatures that examined the relationship between liquidity and profitability by the use of Lending spread as proxy for measuring bank’s performance (profitability) whereas others used either Return on Assets(ROA) or Return on Equity (ROE).

1.7 Scope of the Study

The study “Effect of liquidity on bank’s performance” was limited to just UBA plc, within a period of seven (7) years, from 2010 to 2017.

1.8 Operational definition of terms

Liquidity: This is the ability of a bank to fund increases in assets and meet obligations as they fall due, without incurring unacceptable losses.

Liquidity Management: It is the ability of the bank to manage the liquidity position so that neither the liquidity nor profitability will suffer. It involves the provisions for the withdrawal of deposits, short-term cash cyclical and circular cash requirement of the apex financial institutions.

Bank Deposits: There are funds deposited in a bank. It is divided into demand, savings and time deposits.

Demand Deposits: This is also known as checking account deposit payable on demand that is without prior notice.

Bank: This is an establishment authorized by a government to accept deposits, pay interest, clear cheques, make loans, act as an intermediary in financial transactions and provide other financial services to its customers.

Savings Deposits: This type of deposit is usually evidenced by a passbook under which the depositor/customer of the bank is required to notify the bank before withdrawal. But it is not so in practice.