THE IMPACT OF LIQUIDITY MANAGEMENT ON DEPOSIT MONEY BANKS’ PERFORMANCE IN NIGERIA

CHAPTER ONE

INTRODUCTION

Background to the study

The unique role of banks as engine of growth in any economy has been widely acknowledged. Banks occupy central position in the country’s financial system and are essential agents in the development process. The intermediation role of banks can be said to be a catalyst for economic growth as investment funds are mobilized from the surplus units in the economy and made available to the deficit units. By intermediating between the surplus and deficit units within an economy, banks mobilize and facilitate efficient allocation of national savings, thereby increasing the quantum of investments and hence national output. Banks as financial intermediaries provide avenue for people to save incomes not expended on consumption. It is from the savings accumulated that they extended credit facilities to the entire economy. To perform their role effectively deposit money banks (DMBs) have to be adequately liquid. This implies that the survival of deposit money banks depends largely on its liquidity, because illiquidity being a sign of imminent distress can easily erode the confidence of the public in the banking sector hence sound liquidity is inevitable.

Liquidity management helps deposit money banks to maintain stability in operations and earnings by serving as a guide to investment portfolio packaging. Effective liquidity management serves as a veritable tool through which deposit money banks maintain the statutory requirements of the central bank as it affects the proportion of deposits to liquid assets and deposits to loans and advances. Liquidity management reduces the incidence of bankruptcy and liquidation which can be the later effect of illiquidity, and help them to achieve some margin of safety for their customers’ deposits. Adequate liquidity helps banks to sustain public confidence of the depositors and the financial markets. Liquidity management assists banks in trading off between risk and return; and liquidity and profitability. It serves as a tool through which deposit money banks avoid over liquidity and under liquidity and their consequences. It also enables the banks to avoid forced sales of unfavourable and unprofitable venture or its assets to generate cash. It is for this reason; governments of countries through their apex bank and other relevant authorities formulate reform policies and programme for banking industry (Olagunju, Adeyanju, and Olabode 2011).

The importance of accurate liquidity management cannot be over stressed as it reveals the liquidity positions of the banks through which the operators of the financial market and other creditors adjudged the credit worthiness of the banks. Liquidity management requires an appraisal of holdings of assets that may be turned into cash. The determination of liquidity adequacy within this framework requires a comparison of holding of liquid assets with expected liquidity needs.  The stock concept of liquidity management is widely used and involves the application of financial ratios in the measurement of liquidity positions of deposit money banks. One of the financial ratios used in such measurement is liquidity ratios which measures the ability of the bank to meet its current obligations. Other ratios which have been developed to measure liquidity are liquid assets to total assets; liquid assets to total deposits; loans and advances to deposits. Calculating the ratio of liquid assets to total assets explains the importance of a bank’s liquid assets among its total assets. It indicates the proportion of a bank’s total assets that can be converted into cash at a short notice. Cash ratio to total deposits or assets is another measure of bank liquidity. Its advantage over others is that liquid assets are related directly to deposits rather than to loans and advances that constitute the most illiquid of banks assets.   The ratios serves as a useful planning and control tool in liquidity management since deposit money banks use it as a guide to extend credit to the economy ( Olagunju,  Adeyanju , Olabode 2011).

In an attempt to enhance adequate liquidity the Nigerian government through the monetary authorities have implemented various policies reforms and regulations in banking sector. Such policies and regulations include: The introduction of the 1952 Banking Ordinance which imposed entry conditions for banks in Nigeria. For the first time, indigenous banks were required to have a minimum paid-up capital of £12,500 while foreign banks were required to have a minimum paid-up capital of £100,000. Banks were also required to maintain a reserve into which a minimum of 20 percent of their annual profits had to be paid. The 1952 Banking Ordinance was however ineffective in managing banking liquidity (Nwankwo 1980).

The 1952 Banking Ordinance did not make any provision for assisting banks as there was no Central Bank to act as lender of last resort. The Banking Ordinance of 1958 was subsequently enacted, establishing the Central Bank of Nigeria. The 1958 Banking Ordinance raised the minimum statutory reserve from 20 percent to 25 percent of annual profits; maximum lending to 20 percent of the sum of paid-up capital and statutory reserves; and specified a list of acceptable liquid assets. The 1958 Banking Ordinance was amended in 1962; the amendment raised the minimum paid-up capital of indigenous banks from £12,500 to £250,000 while foreign banks were required to maintain a minimum of £250,000 worth of banks assets (Ajayi and Ojo 1981).

The 1958 Banking Ordinance and its 1962 amendment were repealed in 1969 and replaced by the Banking Act of 1969. The Banking Act of 1969 empowered the CBN to stipulate minimum holding by banks of cash reserves, specified liquid assets, special deposits and stabilization securities. The maximum lending to a single borrower was also increased from 20 percent to 33.3 percent of the paid-up capital and statutory reserves.

IMF supported Structural Adjustment Programme (SAP) was introduced in 1986 in order to encourage competition and market led resource allocation. NCEMA (2003) explain that SAP “relies on market forces and the private sector in dealing with the fundamental problems of the economy.” The package of financial reforms introduced during this period led directly to an increase in deposit money banks from 40, before 1986, to 120 in 1992. In 1990, entry into the Nigerian Banking Sector was further liberalized as foreign banks were allowed to open offices in the country. CBN Decree 24 and the Banks and Other Financial Institutions Decree 25 both of 1991, which repealed the Banking Decree 1969 and all its amendments were thereafter enacted to strengthen the power of CBN to cover new institutions in order to enhance the effectiveness of monetary policy. By 1998, however, the number of deposit money banks in operation whittled down to 89 when the monetary authorities liquidate thirty (30) terminally distressed deposit money banks.

In addition, other frantic efforts were made to enable banks to perform optimally. These include the establishment of the Nigerian Deposit Insurance Corporation (NDIC); Banks and Other Financial Institutions Act (BOFIA) No. 25 of 1991; and the introduction of Prudential Guidelines in strengthening the regulatory and supervisory institutions. The Removal of Credit Ceilings and upward review of capital adequacy standards were also enacted. Also, the introduction of Prudential Guidelines in 1990, increased minimum paid-up capital requirements of deposit money banks from N20 million to N50 million in 1992, N50million to N500 million in 1998 and N500 million to N2 billion in 2002. For banks to become stronger in liquidity, perform better, become more competitive and contribute to the Nigerian economy and attain a global standard, the “mother” of reforms was carried out in 2004. The minimum paid-up capital for deposit money banks was increased from N2 billion to N25 billion (Iganiga, 2010).

The relationship between liquidity management and deposit money banks’ performance is on the notion that well articulated liquidity management in banking industry will improve deposit money banks’ performance. This will in no small measure improve the asset base of deposit money banks and make more credit available to the economy.

1.2      Statement of the Problem

The relevance and the need for liquidity management became clearer in Nigeria when the country witnessed crises in the banking sector, leading to costly bank failures. The Nigerian banking sector suffered inadequate liquidity which led to series of bank failures, and subsequent policy measures. The first took place in the late 1930s and early 1950s mainly due to lack of liquidity management policy and poor asset quality. In fact, 21 of the 25 indigenous banks which had been established in the country by 1954 failed (Okigbo, 1951). The challenges of inefficient liquidity management in banks were also witnessed during the liquidation and distress era of 1980s and 1990s. The negative cumulative effects of banking system liquidity crisis from the 1980s and 1990s lingered up to the re-capitalization era in 2005 and the 2009 post recapitalization.

The intervention of Government in the banking sector to resolve distress crises led to the various reform programme and policies. Such as the Banking Act of 1969 and the establishment of Nigeria Deposit Insurance Corporation (NDIC) in 1988 and liberalization policy in 1986 which re-introduced banks with foreign equity. Systematic distress resurfaced in the Nigerian banking industry again between 1989 and 1998 leading to a number of distress syndromes. The alarming rate of distress scourge in the banking sector between 1997 and 2003 gave birth to the banking sector reform of July 6, 2004 of which consolidation is one of the 13 point reform agenda (Hamman, 2004).  The Central Bank of Nigeria requested all deposit banks to raise their minimum capital base from about US$15 million to US$192 million by the end of 2005. In the process of meeting the new capital requirements, banks raised the equivalent of about $3 billion from domestic capital markets and attracted about $652 million of FDI into the Nigerian banking sector.

Barely five years of what was applauded and considered as a fortified repositioning of banks against liquidity shortage.  The global financial crisis of 2008 also had its claws on the banking sector as several banks remain relatively fragile and incapable of withstanding periodic liquidity shocks .Central Bank of Nigeria (CBN) in 2009 came on a rescue mission to bailout nine (9) out of the twenty four (24) banks with the sum of N620 billion to prevent the occurrence of distress in the industry as some banks had seriously exhibited varying symptoms of distress. The action of the CBN became imperative because the balance sheet of the affected banks had shrunken, their shareholders funds impaired and they had liquidity problem. During the period from December 2008 to December 2009, Nigerian banks wrote off loans equivalent to 66% of their total capital; most of these write offs occurred in the eight banks receiving loans from the CBN. Most of the banks also suffered panic runs and flights to safety during the period (Sanusi, 2009). This development is yet another indication of poor liquidity management which led to poor credit creation in the economy.

According to Central Bank of Nigeria (CBN) 2005 annual report, total credit to GDP ratio fell from 49.8 percent in 2004 to 45.0 percent in 2005, this was in the face of reduction in the minimum reserve requirement from 15 percent to 13 percent during the period. Like any other developing countries, the ratio of credit to GDP has not increased significantly. The quantity, quality, cost and availability of loanable funds have continued to constrain the expansion of businesses and self-employment which are effective channels of job creation due to inconsistent liquidity management policy in the country.

Despite the various policy efforts and the attempts to improve the performance of deposit money banks in Nigeria, a look at the banking industry still showed that the industry return on equity declined from 27.35% in 2004 to 10.6% in 2006, while return on asset declined from 3.12% to 1.61 within the same period. Non-performing credits grew from N316 billion in 2004 to N357 billion in 2005 representing an average of N337 billion in the pre consolidation era. In the post-consolidation era, it was N222 billion in 2006, N388 billion in 2007, N464 billion in 2008 and N620 billion in 2009 (Okafor 2012). By 2012, Industry equity capital decreased by 14.45% from N220.21 billion in December 2011 to N188.39 billion in 2012. Then reserves decreased marginally by 2.21% from N2, 266 billion in 2011 to N2, 216 billion in 2012. The industry total loans stood at N8.15 trillion in 2012, an increase of 12.10% over the N7.27 trillion reported in 2011. The industry recorded a profit-before-tax of N525.34 billion in 2012, representing a significant improvement over the loss of N6.71 billion reported in 2011. Non-interest income on the other hand dropped by 31.92% from N845.66 billion to N575.75 billion (NDIC annual report, 2012).

In addition, only 10 banks were declared sound, 63 satisfactory, 8 marginal and 9 unsound in 2001. However in 2002, there was an improvement. The number of sound banks was 13, the satisfactory banks were 54, marginal were 13 and unsound were 10. The sound banks reduced to 11, the satisfactory banks were 53, and marginal were 14 and the unsound banks reduced to 9 in 2003. After the consolidation specifically in 2006 and 2007, the Sound banks were 4, Satisfactory 17, Marginal 2, and Unsound 1 (NDIC annual report, 2011). The total credit was N2, 840.10 billion and N5, 250 billion respectively in 2006 and 2007. Also, the banks’ Non performing credit was N225.08 billion and N387.99 billion; ratio of non-performing credit to shareholders’ funds was 22.5 and 23.98; and Profit before tax was N181.04 billion and N397.75 billion. The banks’ non-performing credits to total credit ratio was as high as 88.35% with an average capital to risk weighted assets ratio of 11.74% (Cowry Research Desk, 2009).

It was further revealed that there was a quantum leap in the proportion of Reserves to total liabilities as it increased from 0.96% in 2010 to 10.35% in 2011. Total assets increased by 17.31% from N18.66 trillion in 2010 to N21.89 trillion in 2011  In 2012, all the banks, except one met the stipulated minimum capital adequacy ratio (CAR) of 10.0% and industry liquidity ratio at an average of 63.9% against the prescribed minimum of 30.0%. The asset quality of banks improved substantially as it declined to 3.47% at 2012 which was below the threshold of 5.0% (NDIC annual report, 2011).

The foregoing underscores the need to examine the impact of liquidity management on deposit money banks performance in Nigeria. In light of this, several studies have been carried out in Nigeria. Such studies include Agbada and Osuji (2013), Ayodele, et al (2013), Ibe (2013), Uremadu (2012), Adebayo et al (2011), Fadare (2011), Florence (2003), Yauri (2012) Owolabi (2012) and Aremu (2011). Virtually all the works failed to directly examine the impact of liquidity management on deposit money banks performance in Nigeria at the macro level. The main focus has been on liquidity management and banks profitability, and at the micro or firm level. Agbada and Osuji (2013) who examined the relationship between liquidity management and banks performance employed descriptive statistics and Pearson’s Product Moment correlation analysis. This methodology has the drawback of not being able to show the direction of cause and effect. Also, most of the studies, such as Ayodele and Oke (2013), Ibe (2013) and Florence (2003) suffered micronumerousity due to limited data points used in their works. This study therefore examines the impact of liquidity management on performance of deposit money banks in Nigeria with specific reference to banks asset and credit to the economy.

1.3       Research Questions

This study seeks to address the following research questions: