CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

The financial system of both internal and foreign countries has over many years faced with

severe liquidity crisis. This financial crises began with the heavy depression of finance in 1929 .

Asia for instance has between 2007 and 2009 experienced the spill-over effects of the US

subprime mortgage market, ranging from a fall in much Asian stock markets, reduction in value

of currencies, and a decrease in international bank lending.

Liquidity can be seen as the ease with which assets can be converted into cash and cash

equivalents with minimal loss in value. The opportunity cost of remaining liquid is the loss of

earnings from not investing in higher-yielding assets.

Liquidity management of the banking sector which includes that of MFBs is directly related to

the financial performance of financial institutions that was experienced during the global

financial crisis of 2007 to 2008 that hit hard on banks by liquidity management pressures which

led to massive failures by banks. The impact of the crisis was very much on the stock market as

stocks dropped prices affecting many economies, caused huge financial blows resulting to

winding up of institutions, auctioning of houses and unemployment (Majakusi, 2016).

Also, in Nigeria, the challenges of inefficient liquidity management faces in banks were

exposed during the “liquidation and distress” era of 1980s and 1990s. This is so because the

negative cumulative effects of this liquidity crisis stayed up to the re-capitalization era in 2005
in which banks were required to raise their capital base from N2 billion all the way to N25

billion (Agbada & Osuji, 2013).

Thus, this is the primary reason why the Basel Committee continually opines for sound and

prudent liquidity management in all Banks across the globe since it is of paramount importance.

This is so because Basel Committee on Banking Supervision (2008:1) subscribes to the view

that, “Virtually every financial transaction or commitment has implications for a bank‟s

liquidity. Effective liquidity risk management helps ensure a bank's ability to meet cash flow

obligations, which are uncertain as they are affected by external events and other agents'

behaviour. Liquidity risk management is of importance because a liquidity shortfall at a single

institution can have general wide consequences.

On the other hand, Liquidity management is a crucial aspect of any organizational financial

environment that necessitates scrutiny consideration, planning, and management because it

affects the level of trust among stakeholders. It is regarded as an important objective of

financial institutions not t only because it prevents Banks from running into liquidity shortages

but also because it determines their profits.

Liquid should be controlled such that neither too much nor too little is available as firms with

poor liquidity management experience illiquidity and eventually bankruptcy (Majakusi, 2016;

Abdi & Kavale, 2016; Edem, 2017). The need for shareholders to maximize their wealth has

forced the primary goal of profit maximization for businesses. Firms' capital structures,

however, are made up of debt and equity, which refers to borrowed funds and owned assets,
respectively (Umobong, 2015). A company's debt portfolio is mostly made up of short- and

long-term obligations that can only be paid if liquidity is available.

According to Salim and Bilal (2016), a firm's capital structure is determined by its liquidity level

or position. The ability of the company to satisfy its long- and short-term obligations in good

times and bad, as a result of changing economic conditions, is what all investors and creditors

are concerned about. Marozva (2015) when a bank has deprived liquidity management it

possess a major liquidity constrain which negatively affects their capital formation and

earnings.

Hence, if liquidity management is not efficiently managed it may lead to harsh liquidity costs in

financial institutions. Hence, banks face the dilemma on how to classify the level which it can

maintain its assets in order to optimize profit maximization and meeting financial needs of

depositors because every liquidity has a diverse impact on the profitability level. The challenge

is there when banks tend to concentrate on profit maximization neglecting liquidity

management whereas liquidity can lead to both technical and legal insolvency.

The financial crisis of 2007 to 2008 underscored the role of liquidity management to financial

institutions in that very liquid assets have low risk they impose holding opportunity cost to

banks and low returns thus bank managers should trade off risk and return on liquidity. In

circumstances where regulation is absent banks are expected to hold liquid assets to that

extend that they aid to maximizing the financial institutions financial performance. Policy

makers thus have an option to require holding of liquid assets in large amounts to improve the

stability of overall financial system BCBS, (2016)

Mwabui and koori (2019) also asserted that Microfinance banks offer both credit and deposit

facilities to its clients thus liquidity management is important as it evaluates the ability of a firm

to be able to convert its assets to cash easily making the organization to have ready funds to

facilitate its operations in a continual basis.

Though liquidity management has always been a priority in most Banks, the aftermath of the

global financial crisis and lessons learned from it have renewed concerns on Bank’s liquidity

issues. In a state of turmoil in banking markets, customers can withdraw their deposits at any

time and this can lead to bank runs that can lead to costly liquidation of assets of even larger

banks.

Furthermore, the concept of Liquidity management, therefore, involves the strategic supply or

withdrawal from the market or circulation of the amount of liquidity consistent with the desired

level of short-term reserve of money without distorting the profit-making ability and operations

of the banks. It relies on the daily assessment of the liquidity conditions in the banking system,

so as to determine its liquidity needs and thus the volume of liquidity to allot or withdraw from

the market. The liquidity needs of the banking system are usually defined by the sum of reserve

requirements on banks by a monetary authority (CBN 2012).

Also, Liquidity and profitability as performance indicators are very important to the major

stakeholders; shareholders, creditors, and tax authorities. The shareholders are interested in

the profitability of the bank because it determines their return on investment. Depositors are

concerned with the liquidity position of their bank because it determines the ability to respond
to their withdrawal needs, which are normally on-demand or short-term 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 (Olagunji, et al, 2011). The above highlights the relevance and need

for careful liquidity management and monitoring by MFC banks to reduce the uncertainties

A liquidity-profitability trade-off thus exists, since the more liquid an asset is, the less profitable

the asset would be. Dittmar and Mahrt-Smith (2007) found that firms with good corporate

governance quad their cash resources better. Whereas poor governance results in a quick

misspend of excess cash in ways that significantly reduce operating performance. Thus, the

question, “How Liquidity management affects MCF banks’ performance in Nigeria” is very

important.

1.2 STATEMENT OF THE PROBLEM

Liquidity is the ability to meet up with cash obligations in a short term frame as requested.it is

an imperative aspect of management that financial institutions considered as a prior objective

which microfinance banks is not excepted.Eljelly (2004) back it up that Liquidity management

plays a significant role in determining the success or failure of a firm in business performance

due to its effect on a firm’s profitability.Its positive effect on financial performance is so

significant that financial institutions and companies planning to achieve their goals have to take

scrutiny steps towards managing their liquidity area. For instance, Liquidity is best measured

with cash flow statements or budget

But reverse is the case as managers of companies has meagre view towards managing their

liquidity, this in the long run adversely affects profitability as well as its solvency. Most research
conducted have shown a strong positive correlation between bank profits and liquidity while

others have shown a weak Positive correlation that existed.

Bank supervision report (2013) shows that Nigeria deposit money banks registered strong

performance in 2013, exceeding the overall country economic growth. The banking sector in

Nigeria was rated strong in 2013 using the capital adequacy, asset quality, management quality,

earnings and liquidity rating system.

However, studies have it that lack of adequate liquidity in a bank is often featured by the

incapability to meet current financial obligations. Most times it may have the risk of losing

deposits which crumbled its supply of cash and thus forces the institution into disposal of its

more liquid assets. As opined by Pandy (2015), managing monies of a firm in order to

maximized cash availability and interest income on any idle cash is a function of liquidity

management. However, the problems of weak corporate governance, poor capital base,

illiquidity and insolvency, poor asset quality and low earnings are some of the constraints faced

by the banking sector in Nigeria which MFC is not expected.

Also, many researchers have conducted research on liquidity management more often on

industrial sectors and deposit money banks but fewer on MFC banks, research like

johnson(2008) investigated the differences in financial ratio averages between industries.The

results showed that liquidity management has no effect on the firm’s profitability. Moreover,

Kweri (2011) examined the same problem among manufacturing firms. There is no study done

so far on the effect of liquidity management on the performance of Microfinance banks in

Nigeria. It is the light of this, that this study has evaluated the effect of liquidity management on

the financial performance of MFC banks in Nigeria

1.3 OBJECTIVE OF THE STUDY

The main objective of this research is to determine the impact of liquidity management on

performance of Microfinance banks in Nigeria

The specific objectives focus on the following;

1: To determine the impact of capital adequacy on financial performance of MFC banks

2: To determine the impact of maturity gap on financial performance of MFC banks

3: To determine the impact of liquidity ratio on the financial performance of MFC banks

1:4 RESEARCH QUESTIONS

1: To what extent has capital adequacy affects the financial performance of MFC banks

2: To what extent is the impact of maturity gap on financial performance of MFC banks

3: To what extent is the impact of liquidity ratio on the financial performance of MFC banks

1.5 RESEARCH HYPOTHESIS

H1: capital adequacy has a significant impact on the financial performance of MFC banks

H2: maturity gap has a significant impact on the financial performance of MFC banks

H3: liquidity ratio has a significant impact on the financial performance of MFC banks
1.6 SIGNIFICANCE OF THE STUDY.

The result of this study, will be of huge benefit to the management of Microfinance Bank Nigeria

, since it will help to give clear understanding on the benefit that liquidity management is of

paramount to the financial performance of banks. This in return will go a long way to help the

bank achieve its stated objectives, and in the long run increase shareholders wealth and trust of

depositors. In conclusion, this work will be of immense help to future researchers.

1.7 SCOPE OF THE STUDY.

This study is restricted to Microfinance Banks in Nigeria. The study was done to know the

impact of liquidity management on the financial performance of Microfinance banks in low and

medium income earning environments. So, the outcome of this research can be used to gain

insight and make judgement of other banks operating in Nigeria who are situated in a low and

medium income earning environment. All essential information required for this study were

collected from statistical bulletin of central bank of Nigeria.

References

Edem, D. B. (2017). Liquidity management and performance of deposit money banks in Nigeria (1986–
2011): An investigation. International Journal of Economics, Finance and Management

Sciences, 5(3), 146-161

Majakusi, J. (2016). Effect of Liquidity management on the financial performance of commercial banks in
Kenya (Doctoral dissertation, University of Nairobi
Salim, B. F., & Bilal, Z. O. (2016). The impact of liquidity management on financial performance in Omani
banking sector. International Journal of Accounting, Business and Economic Research, 14(1), 545-565.

Pandy, L.M. (2005). Financial Management, New Delhi: Vikas Publishing House.