International Journal of Economics, Commerce and Management

United Kingdom Vol. III, Issue 4, April 2015

http://ijecm.co.uk/ ISSN 2348 0386

BANK PROFITABILITY AND LIQUIDITY MANAGEMENT: A CASE

STUDY OF SELECTED NIGERIAN DEPOSIT MONEY BANKS

Godwin E. Bassey
Department Of Economics, University of Uyo, Uyo, Nigeria
[email protected]

Comfort Effiong Moses

Department Of Economics, University of Uyo, Uyo, Nigeria

Abstract
The issue of liquidity-profitability trade off is well documented in the literature. This study was
carried out to examine the liquidity-profitability trade off of deposit money banks in Nigeria. The
study was carried on fifteen deposit money banks in Nigeria and covered a panel data of 2010
to 2012. Two models were specified and estimated using Ordinary Least Squares (OLS)
technique. The empirical results revealed that there is a statistically significant relationship
between bank liquidity measures-current ratio, liquid ratio, cash ratio, loans to deposit ratio,
loans to asset ratio- and return on equity. However, when return on asset was used as proxy for
profitability, the relationship became statistically insignificant. It was suggested that the banks
should evaluate and redesign their liquidity management strategy so that it will not only optimize
returns to shareholders equity but also optimize the use of the assets.

Keywords: Liquidity, Profitability, DMBs, Trade-off, Nigeria

INTRODUCTION
In every system, there are major components that are paramount to its survival. This is also
applicable to the financial system where deposit money banks contribute significantly to the
effectiveness of the entire system. They do this by providing an efficient mechanism for the
mobilization of resources and efficiently channeling them for productive investment (Wilner,
2000). Therefore, the two major functions of deposit money banks, deposit mobilization and

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credit extension define their financial intermediation role in the economy. However, efficient
financial intermediation by a deposit money bank demands the purposeful attention of the
banks management to the conflicting goals of liquidity and profitability. Both goals run in
opposite direction in the sense that an attempt by a bank to achieve higher profitability will
certainly take a toll on the liquidity level and solvency position and vice versa (Olagunji,
Adenanju and Olabode, 2011).
Liquidity is the ability of a deposit money bank to pay its short-term obligations to its
depositors and creditors. On the other hand profitability is the measure of the difference
between the banks operating expenses and income. However, liquidity and profitability can be
likened to two centrifugal forces with contradictory objectives which at all times threaten to pull
the bank apart. Practically, profitability and liquidity can be used as objective indicators of not
only deposit money banks but all profit oriented organizations (Eljelly 2004).
Profitability and liquidity as performance indicators are very important to the major
stakeholders: shareholders, creditors and tax authorities. 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 may
be. The tax authorities are interested in the profitability of the banks in order to determine the
appropriate tax obligation (Olagunji, et al., 2011).
The contradictory nature of liquidity and profitability can be explained by the intuitive
reasoning that a bank operating with high liquidity (and in the process tying down investable
funds) may have a low insolvency risk, but with a trade-off of low profitability. Conversely, a
bank operating at a low liquidity level (and thus freeing investible funds) may face high
insolvency risk, but with a trade off of higher profitability.
In the Nigerian case, the operating environment is so competitive and tense that any
deposit money bank that hopes to survive must ensure an astute management of its profitability
viz-a-viz its liquidity level as both variables can make or mar its future. It is therefore self-evident
that every deposit money bank needs to strike the right balance between its liquid assets and
total assets to maintain its liquidity (meeting short-term obligations to depositors and creditors)
and remain profitable (adding value to shareholders wealth).
The challenges of inefficient liquidity management of banks in Nigeria were brought to
the fore during the liquidation and distress era of the late 1980s and early 1990s. The negative
cumulative effects of the banking system liquidity crisis from the 1980s and 1990s lingered up to
the re-capitalization era in 2005 in which banks were mandated to increase their capital base
from N2 billion to an astronomical N25 billion. This move by the apex bank was believed would

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stabilize and rectify the bank liquidity problem that was prevalent in the economy (Fadare,
2011).
However, after five years of what was applauded as a fortified repositioning of banks
against liquidity shortage; the Central Bank of Nigeria in 2009 came on a rescue mission to save
five illiquid banks. The global financial crisis of 2008 also had its toll on the already weak
confidence and easy financial conditions, forcing the Central Bank of Nigeria used both
conventional and unconventional measures to inject liquidity into the system.
In its rescue mission in 2009, the Central Bank injected N620 billion to save the five
banks that were operating on negative shareholders funds. The use of such an unconventional
measure became necessary as the regular monetary policy transmission mechanism got
seriously impaired by the liquidity crisis that warranted the setting up of an agency, Asset
Management Corporation of Nigeria (AMCON) to buy out the bad debts of the affected banks
(Fadare, 2011).
It can also be recalled that way back in 2004, although there were 89 deposit money
banks in Nigeria, 10 were assessed as being sound, 51 as satisfactory, 16 as marginal and 12
as unsound (Bassey, 2012). According to Soludo (2004), the problem with the unsound deposit
money banks included persistent illiquidity, poor asset quality, weak corporate governance and
gross insider abuses. Also most of the banks had weak capital base thus constraining them to
overdraw their accounts with the Central Bank of Nigeria and high incidence of non-performing
loans.
From an academic perspective, the literature on the twin concepts of liquidity and
profitability is broad and varied. However, until recently especially in 2013, the empirical
evidence within the Nigeria context had been rather scanty. In addition, some of the studies
carried out on Nigeria such as Olagunji et al. (2011) made use of questionnaires. The results of
such studies need to been taken with caution because of biased responses based on the
position/prejudice of the respondents. Some others such as Uremadu (2012) made use of time
series data with aggregate macro-economic variables of the banking system. This implies the
data were not drawn from the actual financial statements of the commercial banks.
In effect, there is a missing gap in the Nigerian literature as there are few studies that
have extracted data from the annual statements of deposit money banks to empirically
investigate the profitability- liquidity nexus. Thus, this study will not only investigate the effect of
liquidity levels on profitability of commercial banks, it will also contribute to the missing gap in
the extant literature.

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REVIEW OF RELATED LITERATURE

Deposit money banks are business firms and therefore aim to maximize profits. Their profits are
primarily from interest on their earning assets, such as loans and investment. However, most of
their liabilities are deposits payable practically on demand. For that reason, managing healthy
liquidity level while at the same time maximizing profit becomes essential to any bank.
.
Concepts of Liquidity and Profitability
Concept of Liquidity
According to Olagunji, et al. (2011), liquidity refers to the ability of a bank to ensure the
availability of funds to meet financial commitments or maturing obligations at a reasonable price
at all times. Put differently, bank liquidity means banks having money when they need it
particularly to satisfy the withdrawal needs of their customers. The survival of deposit money
banks depends greatly on how liquid they are, since illiquidity, being a sign of imminent distress,
can easily erode the confidence of the public in the banking system and results to run on
deposit.
Liquid assets should be marketable or transferable. This means, they are expected to be
converted to cash easily and promptly, and are redeemable prior to maturity. Another quality of
liquid assets is price stability. Based on this characteristic, bank deposits and short term
securities are more liquid than equity investments due to the fact that the prices of the former
are fixed than the prices and value of the later (Richard, 2013)

Concept of Profitability
The issue of profitability is a contentious subject that a bank has to consistently face. Profit is
the disparity between expenses and revenue over a period of time, normally one year. As
explained by Heibati, Nourani and Dadkhah (2009), a business is organic; it survives and grows.
Therefore, it is important that a bank earns profit for its long term survival and growth. It is also
necessary that enough profit must be earned to maintain the activities of the business to be able
to obtain funds for expansion and growth of the bank.
Agbada and Osuji 2013 argued that corporate profit planning remains one of the most
difficult and time consuming aspects of bank management because of the many variables
involved in the decision, which are outside the control of the bank. It is even more difficult if the
bank is operating in a highly competitive economic environment, such as that of Nigeria.
According to Tabari, Ahmadi and Emami (2013) the profitability variable is represented
by two alternative measures: the ratio of profits to assets, i.e., the return on assets (ROA) and
the returns to equity ratio (ROE). In principle, return on assets ROA reflects the ability of a

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banks asset to generate profit, although it may be biased due to off-balance-sheet activities.
ROE indicates the returns to shareholders on their equity and equals ROA times the total
assets-to-equity ratio.

Theories of the Relationship between Liquidity and Profitability

A number of theories have been put forward which seek to provide insight into the underlying
relationship between liquidity and profitability of deposit money banks. The basic question which
the underlying theories attempt to answer is how does liquidity affect profitability in banking?
Osborne, Fuertes and Milne (2012) postulated that higher liquidity is often costly to banks,
implying that higher liquidity reduces profitability. However, according to the trade-off theory,
higher liquidity may also reduce a banks risk and hence the premium demanded to compensate
investors for the costs of bankruptcy. (Osborne, et al. 2012)
According to conventional corporate finance theories, a bank in equilibrium will desire to
hold a privately optimal level of liquidity that just trades off costs and benefits implying a zero
relationship at the margin. However, capital requirement imposed by monetary authorities, if
they are binding, forces banks to hold liquidity in excess of their private optimal level and hence
force banks above their internal optimal liquidity level (Miller, 1995, Bussen et al. 1989).
Furthermore, since banks optimal liquidity level is likely to vary over the business cycle,
typically rising when there are higher expected costs of distress, the relationship between
liquidity and profitability is likely to be highly cyclical, becoming more positive during the periods
of distress as banks that increase their liquidity improve their profitability (Osborne, et al. 2012).
Thus, there may be a positive or negative relationship between liquidity and profitability in the
short-run depending on whether a bank is above or below its optimal liquidity level.
Flannery and Rangan (2008) assert that indeed if banks are successful in attaining their
optimal liquidity level there may in fact be no short-run relationship at all, since the standard first
order conditions imply that any change in liquidity has no impact on profitability. However, the
long run, regulatory liquidity requirements may be binding. This implies that higher liquidity only
reduces profitability if banks are above their optimal liquidity level, for example due to regulatory
requirements or unexpected shock (Flannery and Regan 2008).
In corroboration of the above, Osborne, et al. (2012) opined that banks optimal liquidity
level rises during periods of banking sector distress, since in such conditions the expected cost
of bankruptcy rises. Consequently, it is expected that the average relationship between liquidity
and profitability across banks will be cyclical. This is because in a distressed environment banks
tend to be below their optimal liquidity level, whereas during normal conditions, banks may
either meet their optimal capital level or not, in which case the relationship would be

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approximately zero, or overshoot, in which case banks can increase profitability by reducing the
liquidity level (Osborne, et al. 2012).
A bank with a higher liquidity level has more chances of surviving and improving
profitability in the future. Allen and Marguez (2011) argued that this may result in large voluntary
liquidity buffer in competitive markets, since the higher liquidity is a more effective guarantee of
the banks solvency and therefore allows the bank to offer more surplus to borrowers. The effect
is to increase banks optimal liquidity level.
Agbada and Osuji (2013) captured the relationship between liquidity and profitability
rather succinctly. According to them: Maximum safety or in simple language we can say
liquidity can be attained only if the banks keep high amount of cash against the deposits they
hold. But if they do this, this will not bring profit for the banks. Similarly, if they go the other way
round that is they only keep investing and trying to increase the profitability factor then they will
have illiquidity problem if customers demand for much cash in a given period.
Thus, the authors advocated that a good banker should try to reconcile the twin
conflicting objectives by actually working out a good portfolio mix. This can be done by
analyzing the situation, studying the objectives and therefore choosing a diversified and
balanced asset portfolio.

Previous Empirical Studies

The liquidity profitability trade-off has been of interest to scholars for quite a long time now.
The number of empirical studies that have been carried out to ascertain the relationship
between liquidity and profitability of deposit money banks has increased. These studies
provided the theoretical and analytical framework that supports this work. However, to make the
review of the empirical evidence specific to the topic of the study, a special section is devoted to
the research carried out on Nigerian banks.
In a study on the determinants of the Tunisia banking profitability for ten banks for the
period 1980 to 2000, Naceur (2003) observed that high net interest margin and profitability are
likely to associate with banks with high amount of capital and large over-heads. Further, the
empirical results of the study also indicated that other determinants such as loans has positive
and bank size has negative impact on profitability.
The profitability of European banks during the 1990s was investigated by Goddard et al.
(2004) using pooled cross-sectional time-series and dynamic panel models. Their model for the
determinant of profitability incorporates size, diversification, risk and ownership type, as well as
dynamic effects. They found that despite intensifying competition there is significant persistence

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of abnormal profit from year to year. The evidence for any consistent or systematic size-
profitability relationship was relatively week.
By calculating the parameters of banks performance in four groups of profitability,
liquidity, efficiency and capital, Heibati et al. (2009) examined and compared the performance of
private banks in Iran and Arabic countries of Persian Gulf area. The empirical results from
regression analysis of cross-country panel data of the banks showed statistically significant
relationship between liquidity and profitability of the banks especially during initial years of their
activity.
The effect of liquid asset holdings on the profitability of U.S. and Canadian banks was
investigated by Bordeleau et al. (2010). The empirical results from ordinary least squares
regression analysis of panel data of the banks suggested that profitability is improved for banks
that hold some liquid assets. However, there is a point at which holding-further liquid assets
minimizes a banks profitability, all else equal. Furthermore, the empirical results from the study
also indicated that this relationship varies depending on a banks business model and the state
of the economy.
Javaid et al. (2011) analyzed the determinants of top ten banks profitability in Pakistan
over the period 2004 to 2008. They focused on the internal factors only. They used the pooled
ordinary least square (POLS) method to investigate the impact of assets, loans, equity, and
deposits on one of the major profitability indicators of banks which is return on assets (ROA).
The empirical results found strong evidence that these variables have a strong influence on
profitability. However, the results showed that higher total assets may not necessarily lead to
higher profits due to diseconomies of scale. Also, higher loans contribute toward profitability but
the impact is not significant. Equity and deposits have significant impact on profitability.
Imad et al. (2011) studied a balanced panel data set of Jordanian banks for the purpose
of investigating the nature of the relationship between the profitability of banks and their liquidity
level for ten banks over the period 2001 to 2010. Using two measures of banks profitability: the
rate of return on assets (ROA) and the rate of return on equity (ROE), the results showed that
the Jordanian banks liquidity explain a significant part of the variation in banks profitability.
High Jordanian bank profitability tends to be associated with well-capitalized banks, high lending
activities, low credit risk, and the efficiency of credit management. Results also showed that the
estimated effect of size did not support significant scale economies for Jordanian Banks.
The relationship between liquidity and the profitability of banks listed on the Ghanaian
Stock Exchange was investigated by Lartey and Boadi (2013). The study was carried out on
seven of the nine listed banks. The researchers made use of the longitudinal time dimension
model. Specifically the panel method time series analysis and profitability ratios were computed

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from the annual financial reports of the seven banks. The trend in liquidity and profitability were
determined by the use of time series analysis. It was revealed that for the period 2005 to 2010,
both liquidity and profitability had a downward trend. The main liquidity ratio was regressed on
the profitability ratio. The result revealed that there was a positive and statistically significant
relationship between liquidity and profitability of the listed banks.

Empirical Evidence on Nigerian Banks

The empirical evidence on Nigerian banks is reviewed in this sub-section. A study which
investigated the relationship between liquidity and profitability of some selected banks and
companies quoted in Nigerian Stock Exchange was that of Obiakor and Okwu (2011). The
central objective of the study was to examine the nature and extent of the relationship between
liquidity and profitability and also to determine whether any cause and effect relationship existed
between the two performance measures. Analysis was based on accounts of the banks and the
companies for the relevant period. A model of perceived functional relationship was specified
and estimated using correlation and regression analysis. The results indicated that while a
trade-off existed between liquidity and profitability in the banks with a negative but insignificant
impact, the two variables were positively correlated.
Uremadu (2012) carried out a study on the effect of capital structure and liquidity on the
profitability of selected Nigerians banks. Time series data for the 1980 to 2006 period was used
for the study. The data was analyzed using descriptive statistics and regressive distributed lag
(ARDL) model. The empirical results indicated a positive and significant relationship between
cash reserve ratio, liquidity ratio, corporate income tax and banks profitability. On the other
hand, there was negative and significant relationship between savings deposit rate, gross
national savings, balances with the central bank, inflation rate, foreign private investment and
bank profitability.
Ibe (2013) investigated that impact of liquidity management on the profitability of banks
in Nigeria. Three banks were randomly selected to represent the entire banking industry in
Nigeria. The proxies for liquidity management include cash and short-term fund, bank balances
and treasury bills and certificates, while profit after tax was the proxy for profitability. Elliot
Rosenberg Stock (ERS) stationary test model was used to test the association of the variables
under study, while regression analysis was used to test the hypothesis. The result showed that
there is a statistically significant relationship between the variables of liquidity management and
profitability of the selected banks.
The study by Kehinde (2013) critically examined the relationship between credit
management, liquidity position and profitability of selected banks in Nigeria using annual data of

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ten banks over the period of 2006 and 2010. The results from ordinary least squares estimate
found that liquidity has significant positive effect on Return on Asset (ROA).
Agbada and Osuji (2013) explored the efficacy of liquidity management and banking
profitability performance in Nigeria. Profitability and Return on Capital Employed (ROCE) were
adopted as proxy variables. Findings from the empirical analysis were quite robust and clearly
indicated that there was a statistically significant relationship between efficient liquidity
management and banking performance, and that efficient liquidity management enhances the
soundness of the banks.
Adeyinka (2013) examined the effect of capital adequacy on profitability of deposit-taking
banks in Nigeria. It sought to assess the effect of capital adequacy of both foreign and domestic
banks in Nigeria and their profitability. The study presented primary data collected by
questionnaires involving a sample of five hundred and eighteen (518) distributed to staff of
banks with a response rate of seventy six percent. Also, published financial statements of banks
were used from 2006 to 2010. The finding from the primary data analysis revealed a non-
significant relationship but the secondary data analysis showed a positive and significant
relationship between liquidity adequacy and profitability of bank. This implies that for deposit-
taking banks in Nigeria, liquidity adequacy plays a key role in the determination of profitability. It
was discovered that liquidity and profitability are indicators of bank risk management efficiency
and cushion against losses not covered by current earnings.

RESEARCH METHODOLOGY
Research Design
This study is quantitative by nature and explanatory by design. Its quantitative nature is hinged
on the fact that it carried out a statistical analysis of the panel data of the variables specified in
the models. The research is explanatory because it seeks to explain the trade-off or causal
relationship between bank profitability and liquidity.. In essence, the intention is to provide a
prognosis of the investigated phenomenon with a view to recommending appropriate liquidity
management strategy for the banks (Alveston and Skoldberg, 1994).

Hypotheses
H01: There is no statistically significant relationship between bank liquidity and returns on
equity of DMBs.
H02: There is no statistically significant relationship between bank liquidity and returns to
asset of DMBs.

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Specification of the Models

Subsequent to hypotheses setting, to provide an analytical basis to test their validation we
reduce them to mathematical statements. However, in specifying the mathematical models, we
relied on the theories of the link between liquidity and profitability in line with Saleen et al, (2011)
and Agbada and Osuji (2013).
The mathematical representations of the functional form that represent our stated
hypotheses are expressed as follows:
ROEt = F (CRRt, LTAt, LADt, CTDt, LNAt) - - (1)
ROAt = F (CRRt, LTAt, LADt, CTDt, LNAt) - - (2)
where:
ROEt = Return on equity of banks in period t
CRRt = Current ratio i.e. current asset to current liability
LTAt = Liquid assets to total asset ratio
LADt = Loans and advances to deposits ratio
CTDt = Cash to total deposits ratio
LNAt = Loans and advances to total assets ratio
ROAt = Return on assets of the banks in period t

Equations (1) and (2) are mere mathematical expressions that cannot be estimated in their
present forms. Thus, to make them adaptable for regression analysis and estimation, equations
(1) and (2) are expressed linearly as follows:
ROEt = a0 + a1CRRt + a2LTAt + a3LADt + a4CTDt + a5LNAt + Ut (3)
ROAt = b0 + b1CRRt + b2LTAt + b3LADt + b4CTDt + b5CTDt + Ut (4)
where a0 a5, b0 - b5 are variables coefficients which were estimated. Ut is the stochastic
element representing all other unspecified influence on return on equity and return on asset.
With regards to the algebraic signs of the parameter estimates, the a priori expectations are as
follows:
ROEt <0; ROEt <0; ROEt> 0; ROEt < 0; ROEt > 0 - (5)
CRRt LTAt LADt CTDt LNAt

This means that, all things being equal, return on equity is negatively impacted by current ratio,
liquid asset to total asset ratio, cash to total deposit ratio, while it is positively impacted by loans
and advances to deposit ratio and loans and advances to total asset ratio. The same a priori
expectations hold true with respect to return on asset.

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Population, Sample Size and Sampling Technique

The population consists of the 22 operational banks in the Nigerian economy. However, for the
purpose of the study, the researchers opted for 15 banks which could be regarded as fairly
representative of the banking sector.
The banks selected were based on the fact that they have a wide branch network and
timely published financial results that are readily available in their website and also posted on
the internet. The selected banks are listed below:
1. First Bank
2. UBA Bank
3. Zenith Bank
4. GT Bank
5. Access Bank
6. Diamond Bank
7. Fidelity Bank
8. Sterling Bank
9. Eco Bank
10. Skye Bank
11. Unity Bank
12. Union Bank
13. Mainstreet Bank
14. Stanbic IBTC Bank
15. Wema Bank

Type and Sources of Data

Panel data of the selected banks were used to carry out the econometric analysis. The data on
the profitability and liquidity variables were obtainable from the annual published reports of the
DMBs.

Analytical Technique
The analytical technique that was applied to estimate models (3) and (4) is the Ordinary Least
Squares (OLS) multiple regression model. According to Koutsouyiannis (1977), OLS is more
commonly used of all the regression techniques because of its best, linear, unbiased (blue)
properties.

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ANALYSIS & RESULTS

Descriptive Analysis
The data presented in Table 1 were extracted from the annual financial statements of the
respective banks. The computation of the ratios for each bank is shown as Appendix A. From
the Table, the current ratios (current asset to current liability) of the various banks show some
distinctive but similar characteristics. Specifically, the Table reveals that the current ratio of
some of the banks (First Bank, UBA, Zenith Bank, Access Bank, Diamond Bank, Fidelity Bank,
Stanbic-IBTC Bank, Wema Bank) is greater than 1. This means that the current assets of these
banks provide more than 100 % coverage for current liability. While this might be a good
liquidity management practice it should also be recognized that it implies tying down of
investable funds.
The other banks (Sterling, GT, ECO and Skye) had current ratio that approximated close
to 100 percent coverage. Only Unity, Union and Mainstreet banks had a lower current ratio of
0.78, 0.63 and 0.79 respectively. From the data, there emerges a discernable pattern of current
ratio management of the different banks which can be classified into three categories: those
with more than 100 percent coverage of current liabilities, those with close to 100 percent
coverage and those with less than 100 percent coverage.

Table 1. Liquidity Ratio, Efficiency Ratio and Profitability

Return Return Liquid to
on to Current Asset Loans to Cash to Loans to
S/N Bank Equity Asset Ratio Ratio Deposit Deposit Asset
1 First Bank 0.10 0.013 1.12 0.96 0.89 0.08 0.65
2 UBA 0.10 0.009 1.04 0.93 0.49 0.33 0.34
3 Zenith 0.09 0.03 1.12 0.93 0.64 0.14 0.47
4 GTB 0.24 0.04 0.99 0.82 0.71 0.32 0.47
5 Access 0.04 0.003 1.14 0.91 0.66 0.09 0.47
6 Diamond 0.06 0.003 1.04 0.86 0.83 0.09 0.60
7 Fidelity 0.07 0.013 1.24 0.93 0.79 0.13 0.56
8 Sterling 0.16 0.013 0.81 0.74 0.46 0.11 0.36
9 Eco 0.13 0.01 0.95 0.86 0.64 0.12 0.58
10 Skye 0.07 0.01 0.94 0.75 0.74 0.08 0.53
11 Unity 0.09 0.01 0.78 0.63 0.69 0.11 0.49
12 Union -0.43 -0.30 0.64 0.68 0.30 0.19 0.18
13 Mainstreat 0.13 0.027 0.79 0.86 0.15 0.20 0.10
14 Stanbic-IBTC 0.05 0.01 1.19 0.91 0.89 0.12 0.53
15 Wema -1.52 -0.01 1.08 0.76 0.40 0.23 0.27
Source: Annual Financial Statements of selected Commercial Banks for the Year Ended 2012

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The next liquidity management ratio on the Table is liquid to total asset ratio. The pattern of this
ratio on the Table reveals the different liquidity management approach of the various banks.
There are those (such as First Bank, UBA, Zenith Bank, Access Bank, Fidelity Bank and
Stanbic-IBTC Bank) which maintain a very high liquid to total asset ratio of higher than 90
percent. Others such as GT, Diamond Bank, ECO Bank and Mainstreet Bank maintained
liquidity ratio that is higher than 80 percent. The others consist of those banks maintaining less
than 80 percent, with Union and Unity bringing up the rear with .68 and .63 percents
respectively.
From the analysis so far, it can be seen that many Nigerian banks maintain high liquidity
ratio. This might be due to one of two reasons; it might be that they adopt a rather conservative
approach to liquidity management or due to high cash reserve ratio set by the Central Bank of
Nigeria. Although the high liquidity ratio maintained by the banks is good as a buffer against
illiquidity and insolvency, but it comes at an opportunity cost of lost returns on tied down
investable funds which translate to lower profitability.
The last liquidity management ratio under consideration is cash to total asset ratio. This
is the strongest liquidity management ratio because it provides the clearest indication of a
banks ability to meets its cash obligations instantaneously. This is particularly important in a
cash-based economy such as that of Nigeria.
From Table 1 above, it can be seen that the cash to total asset holdings of the banks are
rather on the low side considering the high cash transactions which take place in the Nigerian
economy.
From the Table 1, only UBA and GT Bank had cash to asset ratio of more than 30
percent. The average ratio in the industry hovered between 10 and 20 percent although
Diamond Bank had the lowest of 9 percent. The low cash holding of Nigerian banks may be
attributed more to incessant bank robbery in the country rather than to strategic liquidity
management. In addition, the banks can easily resort to borrowing from the overnight interbank
market or resort to the Central Bank of Nigeria to bridge any temporary liquidity challenge.
Another possible explanation is the recent move into electronic banking which has curtailed a lot
of cash-based transactions. The practice of keeping low cash to asset ratio may however have
some salutary effect on the profitability of the banks.
The next group of ratios on the Table is those on efficiency management, that is, loans
to deposit ratio and loans to asset ratio. These ratios are fundamental to the profitability of the
banks because they are indicators of how efficiently savings mobilized are being utilized. From
the Table above, with respect to loans to deposit ratio, First Bank, Diamond Bank and Stanbic
IBTC Bank maintain the highest ratio of over 80 percent. They are followed by GT Bank, Fidelity

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Bank and Skye Bank with over 70 percent. The banks with the least loans to deposit ratio are
Sterling, Wema, Union and Mainstreet with 46 percent, 40 percent, 30 percent and 14 percent
respectively.
The next efficiency management ratio is loans to asset ratio. This ratio shows how the
banks efficiently utilize their total assets viz-a-viz the deposits they mobilize. The higher the
loans to asset ratio the more efficient is a bank. However, if this ratio crosses a certain threshold
the bank may face some liquidity problems.
From the Table, it can be seen that the banks with the highest loans to asset ratio are
First Bank, Diamond Bank, ECO Bank, Fidelity Bank, Stanbic-IBTC Bank and Skye Bank with
65 percent, 60 percent, 58 percent, 56 percent, 53 percent and 52 percent respectively. On the
other hand, the banks with the lowest ratios are Wema, Union and Mainstreet with 27 percent,
18 percent, and 10 percent respectively.
We now turn to the two profitability ratios of return on equity and return on asset. With
these two ratios we are able to measure how the inter-mix of the cash management ratios
(liquidity) and efficiency management (profitability) produces different trade-off results on
profitability for the different banks. Despite the fact that this work does not dwell on empirical
determination of the threshold at which liquidity-profitability have either increasing or decreasing
functions, but based on the available data we can draw some reasonable inferences.
To make the analysis lucid, the return to equity and return to asset ratios are discussed
simultaneously for reasons that will soon become obvious and which hold a lot of policy
implications for the purpose of the study.
From Table 1, the trend of return on equity and return on asset reflect some
contradictory patterns. For instance, First Bank has a return of equity of 10 percent but only 1
percent for return on asset. This appears to be the standard trend pattern of both ratios for
virtually all the banks under study. Specifically, UBA and GT bank have respective returns on
equity of 10 and 9 percent, whereas the corresponding returns on asset are 1 and 3 percent
respectively.
Similarly, Access, Diamond Bank and Fidelity Banks with returns on equity of 4, 6 and 7
percent respectively could only produce return on asset of 0.3, 0.3 and 1 percent respectively.
This trend pattern runs through the industry so there is no need to continue representing the
recurring statistic.
We can now draw some inferences from the data presented and discussed based on
Table 1 above. From the Table, it is quite apparent that the different banks have different
portfolio mix of cash management ratios as well as efficiency management ratios. However, one
feature that seems to be consistent is the rather low return on asset viz-a-viz return on equity.

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Although banks usually have asset base that outstrip shareholders equity but the disparity
between both returns still appears rather wide.
It may be inferred that the current liquidity management strategy adopted by the banks
might be one in which the threshold of optimized return on equity has not been reached while
that of maximizing return on asset has been passed. There is therefore a need for the banks to
take a closer look at the current liquidity management strategy for possible re-evaluation and
redesign in order to produce better results with respect to return on asset. The current practice
is not optimizing their operating assets despite the impressive annual profits they may be
positing.

Regression Analysis
The models specified for the study were estimated using Ordinary Least Squares (OLS) multiple
regression. The regression analysis was carried with e-views version 8 statistical software. The
panel data were obtained from the financial statements of the observed Deposit Money banks.
The first result is that of return on equity as the dependent variable, while the second one is that
of return on asset.

Model 1: Liquidity and Return on Equity

Table 2. The Regression Result of Model 1

Dependent Variable: ROE
Method: Least Squares

Variable Coefficient Std. Error t-Statistic Prob.

CRR -3.663095 1.062026 -3.449157 0.0073

CTD -0.11944 .0590362 -2.023172 0.0265
LAD 1.940679 1.008901 1.923557 0.0446
LNA 1.063313 0.421623 2.521951 0.0433
LTA -4.770767 1.477907 -3.228056 0.0104
C -1.521135 0.738801 -2.058924 0.0696

R-squared 0.750281
Adjusted R-squared 0.685992
S.E. of regression 0.318940
F-statistic 5.346983 Durbin-Watson stat 1.510643
Prob(F-statistic) 0.035320

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The estimated regression result presented in Table 2 is satisfactory in terms of the algebraic
signs of the coefficients as they conform to our a priori theoretical expectation. Specifically the
estimated equation shows that current ratio, liquid ratio and cash to asset ratio are decreasing
functions of return on equity while loans to deposit ratio and loans to asset ratio are increasing
functions of return on equity.
Numerically, a percentage increase in current ratio, liquidity ratio and cash to deposit
ratio will affect return on equity negatively by 3.66 percent, 4.77 percent, and 0.12 percent
respectively. Conversely, a percentage increase in loans to deposit ratio and loans to asset ratio
would affect return on equity positively 1.94 percent and 1.06 percent respectively.
The statistical characteristics of the equation are quite strong. All the coefficient
estimates are statistically significant at the 5 percent level. This is because the prob (t-static) of
the coefficient estimates are less than 0.05 which by inference from statistical decision theory is
indicative of statistical significance.
The R2, coefficient of determination, of 0.7503 is quite high. It indicates an excellent
goodness of fit of the estimated regression line. This means that if we plot the actual data to the
estimated regression line most of the data will cluster around it. Furthermore, the R 2 shows that
75.03 percent of the total variation in returns on equity is explained by the joint influence of
independent variables. The balance 24.97 percent is explained by other variables not captured
by the model which is why the stochastic error term was specified in the econometric model.
The overall regression result is statistically significant at the 5 percent level. This
assertion is based on the F-statistic with a value of 5.3470 and probability (F = statistic) which is
less than 0.05 and thus is statistically significant in line with statistical decision theory.
The Durbin-Watson statistic of 1.5106 is less than 2 and greater than the R-square of
0.7503 which according econometric assumption indicates that the result is free from
autocorrelation between successive error terms. Thus, the t-
statistic, R2 and F- statistic are statistically reliable and the entire regression result is acceptable.
Given that the F-statistic is statistically significant at the 5 percent level, we reject the null
hypothesis of the statistical insignificance of the joint coefficient estimates. In effect, we accept
the alternative hypothesis that there is a
statistically significant relationship between current ratio, liquid ratio, cash ratio, loans to deposit
ratio, loans to asset ratio, and return on equity.

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4.2.2 Model II: Liquidity and Return on Asset

Table 3. The Regression Result of Model 11

Dependent Variable: ROA

Method: Least Squares

Variable Coefficient Std. Error t-Statistic Prob.

CRR -0.2693 0.0683 -3.940 0.0117

CTD -0.1302 0.3181 -0.4094 0.6918
LAD 0.3444 0.3664 0.9401 0.3717
LNA 0.5534 0.4831 1.1453 0.2816
LTA -1.0580 0.3734 -2.8331 0.0299
C -0.2786 0.1866 -1.4923 0.1698

R-squared 0.4845
Adjusted R-squared 0.4126
S.E. of regression 0.0805
F-statistic 1.1247 Durbin-Watson stat 1.6340
Prob(F-statistic) 0.4125

The estimated regression result presented in Table 4.3 is also satisfactory as per the algebraic
signs of the coefficients which all conform to our a priori theoretical expectation. From the result,
current ratio, liquid ratio and cash ratio are negatively related to return on asset, while loans to
deposit ratio and loans to asset ratio are positively related to return on asset.
In numeric terms, a percentage increase in current ratio, liquid ratio and cash ratio will
have 0.27percent, 1.06 percent and 0.13 percent negative impact on returns on asset. On the
other hand, a percentage increase in loans to deposit ratio and loans to asset ratio will have
0.34 percent and 0.55 percent positive impact on returns on asset.
However, the statistical characteristics of estimated model 2 are weak. Only the
coefficient estimates of current ratio and liquid ratio are statistically significant because their
respective probability [t-statistic] of 0.01 and 0.03 are less than 0.05. The coefficient estimates
of cash ratio, loans to deposit ratio and loans to asset ratio are statistically significant because
their respective prob. (t statistic) of 0.69, 0.37 and 0.28 are all greater than 0.05.
The R2, coefficient of determination, of 0.4846 is low. It is an indication of a poor
goodness of fit of the estimated regression line. Specifically it shows that of the total variation in
returns to asset only 48.46 percent is explained by the joint influence of the independent
variables. The remaining 51.54 percent is explained by the stochastic error term.
The F-statistic of 1.1245 has a prob. (F-statistic) of 0.41 which is greater than 0.05, thus
making it statistically insignificant in line with statistical decision theory. The Durbin-Watson

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statistic of 1.6340 is less than 2 and greater than the R 2 of 0.4845 which indicates that the result
is free from autocorrelation as stipulated by econometric assumption of ordinary least squares.
Given that the F-statistic is statistically insignificant at the 5 percent level we cannot
reject the null hypothesis of the statistical insignificance of joint coefficient estimates. In effect,
we accept the null hypothesis that there is no statistically significant relationship between
current ratio, liquid ratio, cash ratio, loans to deposit ratio, loans to asset ratio and return on
asset.

DISCUSSION OF THE EMPIRICAL RESULTS

The empirical results of the regression analysis are quite fascinating for one outstanding reason;
whereas the relationship between return on equity and the independent variables is statistically
significant, that between return on asset and independent variables is statistically insignificant.
In essence, while model I is statistically significant model II is statistically insignificant.
The natural question is why? To answer the question we will draw inference from the empirical
results.
For one, the results show that liquidity management of commercial banks have a
significant impact on the profitability of returns to shareholders but has a weak impact on the
profitability of returns to asset. These results suggest that despite the huge profit declared by
Nigerian commercial banks annually; their liquidity management does not optimize the use of
assets.
Drawing from the above, we can infer that the current liquidity management approach of
commercial banks need to be evaluated and redesigned to increase their profitability beyond
present levels. Although there is a need to be cautious in the redesign of the banks liquidity
management because it should not over focused on profitability at the expense of the all
important issue of liquidity.
We now come to the main thrust of this research work: the trade off between profitability
and liquidity. To achieve this we go back to empirical results. Despite the noticeable disparity
between returns on equity and return on asset, the performance of the liquidity ratio and
efficiency management ratios lend evidence to the trade off hypothesis between liquidity and
profitability.
In both model I and model II that were estimated, the empirical results were emphatic.
The liquidity management variables (current ratio, liquid to asset ratio, and cash to deposit ratio)
had negative impact on profitability, whereas the efficiency management ratios (loans and
advances to total deposits and loans and advances to total asset) had positive impact on
profitability.

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We thus conclude that the liquidity-profitability trade-off is a very challenging issue facing DMBs
in Nigeria. Thus, the research problem of this study has been thoroughly investigated and the
arising hypothesis validated. The subsequent recommendations made in the next section
should, hopefully, provide bankers and policy makers with some insights on how to tackle the
problem.

SUMMARY
The major findings made from conducting the study are outlined below:
(i) Nigerian banks adopt a tight liquidity approach in which there is more than average of
current assets over current liability. Also the deposit to asset ratio is higher than the
loan to asset ratio.
(ii) The empirical results showed that there is a negative and significant relationship
between current ratio, liquid ratio, cash ratio and return on equity.
(iii) There is a positive and significant relationship between loans to deposit, loans to asset
ratio and return on equity ratio. Thus there is a statistically significant relationship
between liquidity and return on equity (the proxy for profitability).
(iv) The liquidity-profitability trade-off is a very challenging issue facing DMBs in Nigeria.

RECOMMENDATIONS
Based on the critical evaluation of the findings, made in this study, we hereby make the
following recommendations with the sincere conviction that they will help to reduce if not totally
eradicate the problems associated with liquidity management and profitability in deposit money
banks in Nigeria.
(i) The liquidity management of Nigerian banks should be more proactive than reactive as
it is presently practiced. The current conservative approach of keeping to a tight liquidity
management, although producing good profitability in terms of return on equity, but only
produces modest profitability in terms of return on asset.
(ii) Since the survival of deposit money banks depend on liquidity management and
profitability, they should not solely concentrate on the profit maximization concept but
also adopt measures that will ensure effective liquidity management. The measures will
help to minimize or avoid cases of excessive and deficient liquidity as their effects are
negative.
(iii) Instead of keeping excessive liquidity as a provision for unexpected withdrawal
demands of the customers, the deposit money banks should find it reasonable to adopt
other measures of meeting such requirements, which can include borrowing and

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discounting bills. In addition, the surplus funds of the commercial banks should be
seasonally invested in short-term instruments of the money market.
(iv) The deposit money banks should create a customer forum where their customers will
be educated on varieties of deposits and the operational requirements of each of them.
A situation where the customers operate any of the deposits as required, the deposit
money banks should be able to estimate the liquidity level to be maintained.
(v) The Central Bank should maintain a flexible minimum monetary policy (MPR) or
discount rate so as to enable the deposit money banks take advantage of the
alternative measures of meeting the unexpected withdrawal demands, and reduce the
tendency of maintaining excess idle cash at expense of profitability.
(vi) Deposit money Banks should schedule the maturity of their secondary reserve assets to
correspond to the period in which the funds will be needed.
(vii) For the fact that the monetary policies of CBN grossly affect liquidity management of
the deposit money banks, CBN should take the interest of the later into consideration
while establishing and implementing these monetary policies in general and the liquidity
ratio in particular. To achieve this feat, CBN is expected to create a forum whereby its
policy makers and the management of deposit money banks interact and dialogue for
acceptable monetary policies.

CONCLUSION
Astute bank management entails delicate balancing of the liquidity and profitability trade-off.
This is because excessive liquidity reduces profitability while excessive liquidity risks exposure,
in pursuit of maximum profitability could lead to the insolvency of a bank. This study was carried
out to empirically examine the relationship between liquidity and profitability of 15 Nigerian
banks. The empirical results indicated that there is statistical significant relationship between
profitability and liquidity when return on equity is used as a measure of profitability but the
relationship becomes insignificant if profitability is proxied by return on asset. Thus, the liquidity
management of Nigerian banks maximizes returns to shareholders but is producing less than
optimal profitability in terms of efficient utilization of assets.

LIMITATIONS OF THE STUDY

This study was conducted using panel data extracted from the financial statements of the
surveyed banks. A major limitation of the study was the difficulty in getting timely and relevant
data due to the delays by banks in publishing their financial statements. Also, attempts by some
banks to window- dressed their accounts for statutory reasons may impact negatively on the

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reliability of the data. Lastly, bank financial statements are published on annual basis. This limits
the number of observations available and impact adversely on the degree of freedom in a
multiple regression analysis of this nature. With improvement in data quality and availability,
further research would be necessary in order to re-examine the major hypothesis contained in
this study.

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APPENDIX
DATA OF LIQUIDITY MANAGEMENT AND PROFITABILITY OF INDIVIDUAL BANKS, 2010-2012

Return on Current Liquid to Loans to Cash to Cash to Return to

STANBIC-IBTC Equity Ratio Asset Ratio Deposit Deposit Asset Asset
2012 0.08 1.12 0.93 0.81 0.2 0.48 0.01
2011 0.04 1.2 0.93 0.81 0.1 0.56 0.01
2010 0.03 1.25 0.87 1.07 0.05 0.55 0.01
0.05 1.19 0.91 0.89 0.11 0.53 0.01

WEMA 2012 -3.9 0.98 0.75 0.42 0.11 0.3 -0.02

2011 -0.68 1.05 0.75 0.45 0.15 0.3 -0.02
2010 0.02 1.2 0.79 0.34 0.424 0.22 0.01
-1.52 1.07 0.76 0.40 0.228 0.27 -0.01

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UBA 2012 0.29 1 0.92 0.57 0.4 0.3 0.02

2011 -0.01 1.03 0.95 0.44 0.3 0.34 -0.001
2010 0.03 1.1 0.93 0.48 0.31 0.38 0.01
0.10 1.04 0.93 0.49 0.33 0.34 0.009

FIDELITY 2012 0.11 1.19 0.94 0.62 0.16 0.48 0.02

2011 0.01 1.2 0.94 0.67 0.15 0.51 0.01
2010 0.08 1.34 0.92 1.07 0.08 0.71 0.01
0.06 1.24 0.93 0.78 0.13 0.57 0.013

UNITY 2012 0.15 0.78 0.68 0.75 0.15 0.51 0.02

2011 0.05 0.86 0.6 0.67 0.1 0.49 0.01
2010 0.07 0.71 0.61 0.66 0.08 0.48 0.01
0.09 0.78 0.63 0.69 0.11 0.49 0.013

MAINSTREAM 2012 0.35 1.14 0.9 0.22 0.19 0.11 0.08

2011 -0.01 0.9 0.8 0.14 0.29 0.07 -0.01
2010 0.06 0.35 0.88 0.08 0.11 0.13 0.01
0.13 0.79 0.86 0.14 0.19 0.10 0.027

STERLING 2012 0.15 0.76 0.7 0.49 0.214 0.39 0.01

2011 0.17 0.66 0.61 0.4 0.09 0.32 0.01
2010 0.15 1 0.9 0.5 0.04 0.38 0.02
0.15 0.80 0.73 0.46 0.11 0.36 0.013

UNION 2012 0.05 0.35 0.69 0.28 0.29 0.15 0.01

2011 -0.43 0.83 0.66 0.36 0.21 0.17 -0.09
2010 -0.83 0.73 0.69 0.27 0.08 0.21 -0.83
-0.40 0.63 0.68 0.30 0.19 0.18 -0.30

SKYE 2012 0.05 1.04 0.75 0.75 0.12 0.53 0.01

2011 0.06 1.03 0.75 0.76 0.06 0.55 0.01
2010 0.09 0.76 0.76 0.7 0.07 0.5 0.01
0.06 0.94 0.75 0.73 0.083 0.53 0.01

ACCESS 2012 0.08 1.01 0.89 0.45 0.11 0.34 0.01

2011 0.06 1.18 0.92 0.78 0.05 0.53 0.01
2010 -0.02 1.22 0.92 0.76 0.13 0.55 -0.01
0.04 1.14 0.91 0.66 0.09 0.47 0.003

DIAMOND 2012 0.3 0.9 0.79 0.68 0.09 0.51 0.04

2011 -0.19 1.16 0.91 0.93 0.04 0.65 -0.04

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2010 0.06 1.07 0.88 0.87 0.14 0.65 0.01

0.06 1.04 0.86 0.82 0.09 0.60 0.003

ECOBANK 2012 0.13 0.95 0.85 0.74 0.13 0.58 0.01

2011 0.14 0.97 0.88 0.58 0.12 0.57 0.01
2010 0.11 0.93 0.86 0.59 0.11 0.6 0.01
0.13 0.95 0.86 0.63 0.12 0.58 0.01

GT BANK 2012 0.31 0.96 0.8 0.67 0.28 0.45 0.05

2011 0.22 0.91 0.78 0.67 0.35 0.44 0.03
2010 0.18 1.09 0.89 0.78 0.35 0.52 0.03
0.23 0.98 0.82 0.71 0.33 0.47 0.036

FIRSTBANK 2012 0.18 1.1 0.94 0.78 0.12 0.61 0.02

2011 0.05 1.15 1 0.8 0.08 0.6 0.01
2010 0.08 1.11 0.94 1.09 0.05 0.74 0.01
0.10 1.12 0.96 0.89 0.083 0.65 0.013

ZENITH BANK 2012 0.06 1.16 0.95 0.61 0.17 0.45 0.04
2011 0.12 1.12 0.93 0.68 0.13 0.48 0.02
2010 0.1 1.1 0.91 0.64 0.12 0.49 0.02
0.09 1.13 0.93 0.64 0.14 0.47 0.027

Sources: Annual Financial Statements of the selected Commercial Banks for the Year Ended 2010-2012

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