THE IMPACT OF LIQUIDITY MANAGEMENT ON FINANCIAL PERFORMANCE OF FIVE NIGERIAN COMMERCIAL BANKS (2005 – 2015)

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CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

Nigeria, often referred to as the ‘Giant of Africa’ became an independent country in 1960. The government of the federation had a constant alternation between the military rulers and the democratically – elected rulers, until it stabilized in 1999 with Chief Olusegun Obasanjo becoming the President. Nigeria was a colonized country by the British before she gained her independence and it was during her pre – independence period that she was given the name Nigeria. The name, which was coined from the River Niger, was given by Flora Shaw.

Before the introduction of currency of exchange, the country was operating a system of trade called the barter system. This system involved the exchange of goods for goods or services for services. This system is an ancient system that was used by our forefathers in their exchange with the British masters coming from the South and the Arabs coming from the North. Due to the diverse trade, it brought about diverse currencies, which can be grouped into two; local/indigenous currency (e.g, iron, animals, salt, feathers, beads, etc), and imported/non indigenous currency (e.g, cowries, manila’s, copper, iron bar, gin and tobacco. (Mint, 2016)

These means of exchange had to be replaced because some of them were limited to a particular area; some were very cumbersome and lacked the distinctive quality of what the modern day exchange means. These limitations brought about the introduction of a uniform and acceptable means of exchange, which were the coin and paper money.

The Nigerian economy has various factors/elements that are vital for the survival of the economy. Financial institutions are seen as one of the elements needed for this survival. They have contributed greatly to the growth of the economy and have helped in providing effective ways by which the resources of the economy have been mobilized and deployed for national development. Commercial Banks are part of the financial institutions.

These banks began to exist in the year 1892 with the first one being African Banking Corporation Ledger Depositor and Co. and was later taken over in 1984 by the bank of the British West African, which later became First Bank of Nigeria PLC and Standard Bank. (Skylar, 2015) After the Second World War, economic activities in the country rose and this brought about the incorporation of more banks. Between 1905 and 1975, about eighteen banks had been established but by 1975, most of them had gone into liquidation or had closed down. It was due to the various shut down that the Central Bank developed a policy that mandated all banks to increase their capital base from N2 million to N25 billion naira (Agbada and Osuji, 2013)

Banks make their own revenue by lending money at a rate higher than the cost of the money that they lend to customers, by remitting the loans that have been imposed on loans and debt securities. They are seen as the backbone of the economy as they facilitate saving and borrowing. Their major function is that of deposit mobilization and credit extension. Due to its varying functions, it is exposed to different problems, one of such is liquidity management. (Johnson, 2017)

Liquidity is said to be the bank’s ability to meet its cash, cheque, and other obligations as well as its loan demand. The liquidity needs of a bank are usually defined by the sum of its reserve requirements imposed on banks by a monetary authority (Central Bank Nigeria, 2012). Liquidity management not only affects the performance of a bank but also its reputation (Jenkinson, 2008). A bank will lose the confidence of its customers if funds are not provided to them when they are needed. The bank’s goodwill may become at stake in this situation.

Liquidity management has become a serious challenge for the modern banks (Comptroller of the Currency, 2001). A bank having good asset quality, strong earnings and sufficient capital may fail if it is not maintaining adequate liquidity (Crowe, 2009).

During the last crisis which occurred in the ‘80s, many banks ran out of liquidity, some had raise funds at a discount in order to meet with the high of demand for urgent cash. Liquidity markets were frozen. Many financial institutions had to review their corporate governance policies in order to accommodate liquidity risk exposures. (Edem, 2017)

Bhattacharyya and Sahoo (2011), argued that liquidity management by Central banks refers to the framework, set of policies and instruments, and the rules that the monetary authority follow in managing systemic liquidity, consistent with the goals of monetary policy.

According to Central Bank’s Monetary, Credit, Foreign Trade and Exchange Policy circular for the fiscal year 2016/2017, it stated that commercial banks as well as merchant banks are expected to maintain a liquidity ratio of 30, 20, and 10 per cent which is subject to review from time to time. The maintenance of this ratio will aid effective liquidity management which is an important factor that has helped maintain bank profits and helped keep the banking institution and the financial system from insolvency. The strategic management for banks has helped at keeping banks solvent and liquid in order for them to earn good profits and remain financially stable (Agbada and Osuji, 2013). In order to keep the confidence, the public has in the financial system and to increase the survival of the financial system of the country, banks have been required to maintain adequate and sufficient amount of cash and near cash assets in order to meet the withdrawal obligations of the public.

1.2       Statement of the Problem

Management of liquidity has been an important agenda for every bank for the past few years in Nigeria. Bassey, Tobi, and Ekwere (2016), stated that for the successful survival of banks, policies should be put in place to guard the effective and efficient management of liquidity which enables them to satisfy their financial obligations to customers, build public confidence to maximize the profit for shareholders.

Failure in liquidity management has a negative effect on bank operation and has a long term effect on the economy as a whole. Liquidity management is seen as the major element in measuring the going concern for banks and this is the reason they have come up with the idea to develop policies to improve the liquidity position, yet the problem is unsolved. Edem (2017) states that, the attempts by bank managers to increase return tend to have negative impact on liquidity which might be dangerous to the banks as this can lead to loss of bank’s patronage, goodwill, deterioration of bank’s credit standings and might lead to forced liquidation of bank’s assets on one hand, and maintaining excess liquidity to satisfy customers’ demands might affect the returns on the other hand.