LIQUIDITY AND LOAN PORTFOLIO PERFORMANCE: EVIDENCE FROM THE NIGERIAN BANKING SECTOR

ABSTRACT

One of the major indicators of financial performance is profitability .Every stakeholder in the banking sector is interested in liquidity and performance(profitability)of the bank, theShareholders are interested in profitability of the bank because it determines their returns on investment. Depositors are concerned with the liquidity position oftheir  banks because it determines the ability of the bank to response 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 bank in order to determine the appropriate tax obligation to the government.

In a bid to see how the interest of the various stakeholders could be protected, the effects of liquidity on the loan portfolio performance of Nigerian Banks was examined. This study found out whether liquidity proxies(loans to deposit ratio and liquidity ratio) have significant impact on the loan portfolio performance (Profitability) of Nigerian banks with Lending spread as proxy for loan performance.

To achieve the objectives of this research, a quantitative research method (secondary data) was adopted. Using purposive data collection approach, the study carried out a time series, cross

sectional analysis on the 12 banks listed on the Nigerian Stock Exchange over a period of 8 years from 2008 to 2015. The selection of the banks was determined by data availability for the period and the data were retrieved from the Annual financial reports of the 12 banks as obtained in the Nigerian Stock Exchange (NSE) and the respective banks’ websites. Panel data regression analysis from Stata statistical software was employed to analyse the data.

The study concluded that there is significant negative impact of both liquidity ratio and loan to deposit ratio on lending spread.That means, profitability is significantly but negatively influenced by liquidity.

Keywords:Liquidity, Loan portfolio, Lending Spread, Profitability, Loans-to- deposit ratio    

CHAPTER ONE

INTRODUCTION

1.1       Background to the Study

The importance of liquidity and profitability of banks has received tremendous attention in the corporate world in recent years. The management of corporate liquidity is one of the most critical areas in determining whether a firm will be profitable or not. Liquidity of a firm represents its ability to carry out all its financial obligations without affecting the business operations. A business cannot run smoothly without the presence of adequate working capital. Therefore, the importance of liquidity makes it necessary for banks to maintain a reasonable amount of their assets in the form of cash in order to meet their short term obligations. According to Saleh, (2014), profit is the bottom line or ultimate performance result showing the net effects of bank policies and activities in a financial year.

Profitability being a measure of loan performance also refers to excess of firm’s revenue over her operational cost or measurement of the rate of return on investment. Enhancement of profitability is one of the ultimate goals of every firm, and generally, banks strive to strike a balance between profitability and liquidity (Niresh, 2012).

The Basel Committee on Banking Supervision (2008) defined liquidity as the ability of a bank to fund increases in assets and meet obligations as they fall due, without incurring unacceptable losses. Liquidity could be risky when a financial firm, though solvent, either does not have enough  financial resources to allow it to meet its obligations as they fall due, or can obtain, such funds only at excessive cost (Vento & Laganga, 2009).

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). This study examined the effect of liquidity on the loan portfolio performance (profitability) of Nigerian banks in other to contribute to the gaps in the previous studies as stated below.