ABSTRACT
This study examined cash and credit management and commercial banks’ liquidity in Nigeria. The major aims of the study were to find empirical evidence of the degree to which effective cash and credit management affects the liquidity performance in commercial banks and how commercial banks can prevent illiquidity by engaging in these practices. Considering the nature
of the survey, quantitative methods of research were applied. In attempt to achieve the objectives of the study, several findings were made through the analysis of the financial statement of various commercial banks used as samples over a period of seven years. The data obtained from Secondary sources were analyzed through with the use of panel data regression and correlation co-efficient. A few hypothesis were formulated and were statistically tested through panel regression model. Findings from the testing of this hypothesis indicate that there is significant relationship between cash and credit management and illiquidity. That means liquidity in commercial banks is significantly influenced by credit and cash management. The study concluded that for the success of operations and survival, commercial banks should not compromise efficient and effective cash and credit management and that both illiquidity and excess liquidity are “financial diseases”. Also, that cash and credit management are high important in order to avoid insolvency or illiquidity. Finally the study recommends that banks should not neglect their responsibility of cash management and focus mainly on credit management.
TABLE OF CONTENT
Page TITLE PAGE……………………………………………………………………………………………………………………………………… I
CERTIFICATION………………………………………………………………………………………………………. II
DECLARATION………………………………………………………………………………………………………… III
DEDICATION……………………………………………………………………………………………………………. IV
ACKNOWLEDGEMENT…………………………………………………………………………………………… V
ABSTRACT……………………………………………………………………………………………………………… VI
TABLE OF CONTENTS………………………………………………………………………………………….. VII
LIST OF FIGURES……………………………………………………………………………………………………. XI
CHAPTER ONE: INTRODUCTION…………………………………………………………………………… 1
CHAPTER TWO: LITERATURE REVIEW…………………………………………………………….. 10
- Introduction……………………………………………………………………………………………………………… 10
- Conceptual clarification……………………………………………………………………………………………… 10
- Analytical Template for Credit Risk Assessment………………………………………………… 17
- The concept of Performing and Non-performing loans………………………………………… 18
- Target Cash Balance……………………………………………………………………………………….. 25
- Cash and Credit Management and Liquidity Performance in Commercial Bank…… 43
- Theoretical Framework………………………………………………………………………………………………. 56
- Hold-up and Soft-Budget-Constaint Theories……………………………………………………… 57
- The Baumol Theory………………………………………………………………………………………….. 58
- Use of Baumol Theory……………………………………………………………………………. 60
- The Line of Credit Model……………………………………………………………………………….. 62
- Conceptual clarification……………………………………………………………………………………………… 10
CHAPTER THREE: METHODOLOGY…………………………………………………………………… 73
CHAPTER FOUR: PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA.
- : Introduction……………………………………………………………………………………………………………. 79
- Graphs Showing the Liquidity Performance in relation to its Credit Risk over Seven years. 81
- Analysis and Interpretation of Credit and Liquidity Performance Trend………………………….. 88
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS……….. 90
BIBLOGRAPHY………………………………………………………………………………………………………… 95
APPENDIX……………………………………………………………………………………………………………….. 102
LIST OF FIGURES
Figure 2.1: The Credit decision as a decision problem Figure 2.2: Elements or Components of Cash Management Figure 2.3: Cash flow Cycle
Figure 4.1: Summary of Data used in the Analysis and Interpretation of Credit Risk and Liquidity Trend.
CHAPTER ONE INTRODUCTION
Background Information
A bank is a financial intermediary and money creator that creates money by lending money to a borrower, thereby creating a corresponding deposit on the bank‟s statement of financial position. Commercial Banks are profit-making organizations acting as intermediaries between borrowers and lenders attracting temporarily available resources from business and individual customers as well as granting loans for those in need of financial support (Drigă, 2012). Commercial banks can also refer to banks or a division of a bank that mostly deals with deposits and loans from corporations or large businesses.
The health of a financial system plays a very important role in the economic development of the country and it failure can have very tragic consequences for such an economy. In developing countries like Nigeria, commercial banks through their functions and activities aid the growth and development of the economy and therefore, are very important to the efficiency and success of the financial system.
Traditionally, it is the belief of every business that profit is a key indicator of success. This is very much true but most business have failed to understand that there is more to profitability than the large figure of retained earnings or reserves in the statement of financial position.
Commercial banks accept deposits from its customers and in turn, generate revenue by lending to individuals and corporate organizations. The statement of financial position of a commercial bank is constituent mostly of loans and advances and bonds as the majority of its asset and deposits as it major liability. This implies that loans make up the bulk of the bank‟s asset and this make it safe to say the life blood of a commercial bank is credit. As a result of lending, credit risk is introduced into the activities of the commercial bank and this is the most critical of all risk faced by the banking institution. If the bank makes bad loans to firms or consumers for example, the bank will be in a crisis if those loans are not repaid (Mavhiki et al., 2012).
As a matter of fact a bank cannot remain in business if it neglects the credit function (Osayeme 2000). Credit risk is of major concern to commercial banks; therefore, commercial banks need to put in place risk management measures to help avoid the risk from blooming into something
greater than they are able to handle which ultimately is illiquidity. Risk management is the human activity which integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources, but credit risk is the risk of loss due to debtor‟s non–payment of a loan or other line of credit (either the principal or interest or both) (Campbell, 2007). There is need for commercial banks to adopt appropriate credit appraisal techniques to minimize the possibility of loan defaults since defaults on loan repayments leads to adverse effects such as the depositors losing their money, loss of confidence in the banking system, and financial instability (kithinji, 2010). Hence, credit management is made necessary for both profitability and liquidity.
Another aspect fundamental to the survival of a commercial bank is its working capital. The major concern of working capital is cash. Though, cash holds the smallest unit of the total current asset, like the blood stream of the human body, it gives strength and vitality to the business enterprise. Cash is king and this hold true irrespective of the business size. The availability of cash balances is a key determinant of a bank‟s competitive ability because it provides the means to invest in people, technology and assets.
Cash is both the beginning and end of working capital cycle which keeps the business going. Hence, every enterprise has to hold necessary cash for its existence. Moreover, steady and healthy circulation of cash throughout the entire business operations is the basis of business solvency. Now-a-days, non-availability and high cost of money have created a serious problem for industry. Nevertheless, cash like any other asset of a company is treated as a tool of profit. Further, the emphasis is on the right amount of cash, at the right time, at the right place and at the right cost. In the words of R.R. Bari, “Maintenance of surplus cash by a company unless there are special reasons for doing so, is regarded as a bad sigh of cash management as the holding of cash balance has an implicit cost in the form of its opportunity cost.
Cash may be interpreted under two concepts. In narrow sense, “Cash is a very important business asset, but although coin and paper currency can be inspected and handled, the major part of the cash of most businesses is in the form of bank checking accounts, which represent claims to money rather than tangible property.” While in broader sense, “Cash consists of legal tender, cheques, bank drafts, money orders and demand deposits in banks. Thus, we may conclude that in narrow sense cash means cash in hand and at bank but in wider sense, it is the deposit in banks, currency, cheques, bank draft etc. In addition to cash in hand and at bank, “Cash
management includes management of marketable securities also, because in modern terminology money comprises marketable securities and actual cash in hand or in bank.” Cash management in a commercial bank is therefore indispensable.
Statement of the problem
One of the major and most crucial problems faced by commercial banks now-a-days is liquidation even after these commercial banks have recorded a high level of profit. It is very disturbing that a commercial bank that seems fine suddenly winds-up and this always leaves the customers wondering “How” and “Why.”
Researches carried out over the course of the past few years on the very devastating financial crisis that rocked the banking industry as a whole in 2008-09 have all shown that most commercial banks ran out of cash as bad debts, lack of short-term financing and poor profitable opportunities combined to cause the most severe crisis in the financial sector for decades. But then the question is; how do banks that are already profitable run out of cash? Or how do banks that are already in business not put in place all possible measures to ensure continuous profitability and liquidity?
As a result of these, the major problem identified by this research work as the reason for the failure of these commercial banks is poor management of their finance (cash and credit). In light of the above, the problems identified by this research work are summarized as follows:
- The level of exposure to and the impact of credit risk by commercial banks are not met by proper strategies and tactics that will help manage this risk effectively for control purposes.
- Every time a commercial bank performs it lending function, it introduces credit risk into the business. The exposure to this risk is inversely related to the liquidity position of these banks but they have failed to see how each credit risk they are exposed to has affected their liquidity performance over the years.
- In order to avoid the high cost associated with holding cash whose opportunity cost is the cost of lost interest, commercial banks keep cash balances which are below the target cash balance.
- Banks add the amount of cash required to satisfy its transaction needs to that needed satisfy its compensatory balances to produce a target cash balance. This result to surplus cash which if left idle will cause the firm to lose the profit it would have earned if it had been invested.
Objectives of the study
In the light of problems that have been identified as the major factors that are responsible for the failure of commercial banks in Nigeria, this research work would be used to examine the challenges so as to achieve some specific objectives. The general objective of this study is establishing a relationship between cash and credit risk management and the liquidity of commercial banks. The more specific objectives are:
- To examine the impact of non-performing loans on the liquidity position of commercial banks.
- To carefully investigate the influence of effective credit risk management put in place by these banks on their liquidity performance.
- To show the credit risk exposure and liquidity performance trends of Nigerian commercial banks over a given period of time.
- To develop, explore and evaluate ways in which commercial banks can achieve their target cash balances to meet their various needs so as to avoid insolvency and aid profitability.
Research questions
With a view of achieving the specific objectives stated above, the answers to the following questions are required:
- To what extent does non-performing loans affect the liquidity position of commercial banks?
- What influence does effective credit risk management have on the liquidity performance of commercial banks?
- What relationship exists between the trend of credit risk and the trend of liquidity performance of commercial banks over time?
- Why do commercial banks have to achieve their target cash balances in order to avoid insolvency?
