Final Revised Thesis - Desale

ETHIOPIAN CIVIL SERVICE UNIVERSITY
College of Finance, Development and Management
Department of Development Economics
Factors Affecting Banks’s Liquidity in Ethiopia: The Case of Bank of

Abyssinia.
By
Desale Fentie Tikuye
Master’s Thesis submitted to the Department of Development Economics in

Partial Fulfillment of the Requirements for the Degree of Masters of
Science in Development Economics
June, 2024
Addis Ababa, Ethiopia
Factors Affecting Banks’s Liquidity in Ethiopia: The Case of Bank of

Abyssinia.
By
Desale Fentie Tikuye
Master’s Thesis submitted to the Department of Development Economics in

Partial Fulfillment of the Requirements for the Degree of Masters of
Science in Development Economics
Advisor: - Mezid Nasir (PhD)
June 2024
Addis Ababa, Ethiopia
© 2024 Desale Fentie

Declaration
This is to declare that the thesis entitled “Factors Affecting Banks’s Liquidity in Ethiopia:
The Case of Bank of Abyssinia”, submitted in partial fulfillment of the requirements for the
degree of Master of Science in the Department of Development Economics, Ethiopian Civil
Service University, is a record of original work carried out by me and has never been
submitted to any other institution to get any other degree or certificates. The assistance and
help I received during the course of this investigation have been duly acknowledged.
Name of the candidate: Desale Fentie Date: June 11, 2024 Signature:
Approval of Thesis for Defense

I hereby certify that I have supervised, read, and evaluated this thesis titled “Factors Affecting
Banks’s Liquidity in Ethiopia: The Case of Bank of Abyssinia” by Desale Fentie prepared
under my guidance. I recommend the thesis be submitted for oral defense.
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Approval of Thesis after Defense
As members of the board of examiners, we examined this dissertation/thesis entitled “Factors

Affecting Banks’s Liquidity in Ethiopia: The Case of Bank of Abyssinia” by Desale Fentie we
hereby certify that the thesis is accepted for fulfilling the requirements for the award of the
degree of “Masters of Science in Development Economics”.
Board of Examiners
External Examiner
Name
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Acknowledgements
I would like to extend my sincere gratitude to my advisor Doctor Mezid Nasir, assistant
professor at Ethiopian Civil Service University. Without his insight and wise counsel this
research would not have been a success.
I also wish to extend my gratitude to my families and friends for their unending
encouragement and support throughout the breadth of my study. Thank you all
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Table of Contents
Acknowledgement..............................................................................................................................................i
List of Figures...................................................................................................................................................iv
List of Tables....................................................................................................................................................iv
List of Acronyms...............................................................................................................................................v
Abstract.............................................................................................................................................................vi
CHAPTER ONE................................................................................................................................................1
INTRODUCTION.............................................................................................................................................1
1.1. Background of the Study.......................................................................................................................1
1.2. Statement of the Problem.......................................................................................................................4
1.3. Objectives of the Study..........................................................................................................................7
1.4. Research Question.................................................................................................................................7
1.5. Significance of the Study.......................................................................................................................7
1.6. Scope of the Study.................................................................................................................................8
1.7. Limitation of the Study..........................................................................................................................8
1.8. Organization of the Study......................................................................................................................8
1.9. Ethical Considerations...........................................................................................................................9
CHAPTER TWO.............................................................................................................................................10
LITERATURES REVIEW..............................................................................................................................10
2.1. Concepts of Banks Liquidity...............................................................................................................10
2.2. What is liquidity at a bank?.................................................................................................................11
2.3. Sources of Bank’s Liquidity................................................................................................................11
2.4. Factors Affecting Liquidity.................................................................................................................12
2.4.1. Bank specific factors affecting Liquidity....................................................................................12
2.4.2 Macro-economic Factor................................................................................................................13
2.5. Empirical literature on factors of liquidity..........................................................................................15
2.5.1. Review of International empirical Literatures.............................................................................15
2.5.2. Review of Ethiopian Empirical literatures..................................................................................18
2.6. Research Gap and Justification of this Paper......................................................................................21
2.7. Conceptual frame works......................................................................................................................22
CHAPTER THREE.........................................................................................................................................23
RESEARCH METHODOLOGY....................................................................................................................23
3. Introduction.............................................................................................................................................23
3.1 Research Design..................................................................................................................................23
3.2 Data Type, Sources and Collection.....................................................................................................23
3.3 Sampling Design and Technique.........................................................................................................24
3.4 Data Analysis Method.........................................................................................................................24
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3.5 Model Specification and Variable Description.....................................................................................24
3.5.1 Independent Variables..................................................................................................................25
3.5.2 Dependent Variables.....................................................................................................................26
3.6 Diagnostic tests.....................................................................................................................................26
3.7 Estimation Strategies............................................................................................................................27
3.7.1 Stationary test...............................................................................................................................27
3.7.2 Co-integration Analysis................................................................................................................27
CHAPTER FOUR...........................................................................................................................................28
RESULT AND DISCUSSION........................................................................................................................28
4.1. Introduction..........................................................................................................................................28
4.2. Descriptive Statistics...........................................................................................................................28
4.3. Trend Analysis.....................................................................................................................................30
4.4. Unit Root Test......................................................................................................................................32
4.4.1. Augmented Dickey Fuller (ADF) test.........................................................................................33
4.4.2. Phillips -Perron (PP) tests............................................................................................................34
4.5. Diagnostic Tests...................................................................................................................................35
4.5.1. Test of multicollinearity..............................................................................................................35
4.5.2. Test of heteroskedasticity............................................................................................................37
4.5.3. Serial Correlation.........................................................................................................................38
4.6. Optimal lag length selection................................................................................................................38
4.7. The ARDL Bounds testing result........................................................................................................39
4.8. ARDL model in error correction model..............................................................................................40
4.8.1. Short run in error correction Model.............................................................................................41
4.8.2. Long run in error correction model.............................................................................................42
CHAPTER FIVE.............................................................................................................................................47
CONCLUSIONS AND RECOMMENDATIONS..........................................................................................47
5. Introduction.............................................................................................................................................47
5.1. Conclusion..........................................................................................................................................47
5.2. Recommendation................................................................................................................................49
5.3. Suggestions for future studies.............................................................................................................50
REFERENCE..................................................................................................................................................51
Appendix..........................................................................................................................................................57
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List of Figures
Title Pages
Figure 2.1: Conceptual framework factors affecting liquidity......................................................... 22
Figure 4.1:
Liquidity................................................................................................................... 30
Figure 4.2:
Profitability............................................................................................................... 31
Figure 4.3: Loan Growth............................................................................................................ 31
List of Tables
Table 3.1: Description of the variables, measurement and their expected relationship ……………..... 25 3
Table 4.1: Summary of descriptive statistics
……………………………………………......... 28
Table 4.2: Augmented Dickey-Fuller Unit Root Test
results...................................................... 33
Table 4.3: Phillips -Perron Unit Root Test
results....................................................................... 34
Table 4.4: Correlation Matrix..................................................................................................... 35
Table 4.5: Variance Inflation
Factors.......................................................................................... 36
Table 4.6: Normality test
Result................................................................................................. 36
Table 4.7: Heteroskedasticity
Test.............................................................................................. 37
Table 4.8: Breusch-Godfrey Serial Correlation LM Test
result.................................................. 38
Table 4.9 Summary of Diagnostic test...................................................................................... 38
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Table 4.10: lag selection results for VAR with ten
variables...................................................... 39
Table 4.11: Bound test
result....................................................................................................... 40
Table 4.12: Short Run estimation
result...................................................................................... 41
Table4.13: Long Run estimation
result....................................................................................... 43
List of Acronyms
BOA Bank of Abyssinia
NBE National Bank of Ethiopia
ADF Augmented Dickey-Fuller
PP Phillips perron
ANOVA Analysis of Variance
ARDL Auto-Regressive Distributed Lag
BLUE Best Linear Unbiased Estimator
CAP Capital Adequacy
AIC Akaike Information Criteria
ECM Error Correlation Model
GDP Gross Domestic Product
INFL Inflation
LG Loan Growth
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LIQ Liquidity
NOA Number of ATM
NOB Number of branches
R Interest Rate
Π Profitability
ATM Automatic Teller Machine
FEM Fixed Effect Model
Abstract
This study examines the bank-specific and macro-economic factors affecting liquidity on
Bank of Abyssinia in Ethiopia, covering the period of 1998-2023 using annual time series
data. It is discovered the 26-year observational period. This study has chosen Bank of
Abyssinia as sample case study of the topic. Time series data were sourced variables
including gross domestic product, inflation, profit, interest rate, loan growth, non-performing
loan, capital adequacy ,number of Branches and number of ATM, were used as exogenous
variables on the explained variable; liquidity. Quantitative research approach and
explanatory design were adopted in carrying out this research. Data were collected from
secondary sources and analysed by applying both the descriptive and econometric methods.
The ARDL model to co integration has been applied to find out the short run and long run
determinants of liquidity by using econometric package STATA. The findings of the study
shows that, Gross domestic product, inflation, profit and loan growth have negative and
statistically significant impact on liquidity; On the contrary, non-performing loan & interest
rate have positive and statistically significant impact on liquidity of Bank of Abyssinia in the
long run. On the other hand, Profit, loan growth, gross domestic product and inflation have
positive and statistically significant impact on liquidity while interest rate have negative and
statistically significant impact on liquidity of Bank of Abyssinia in the short run, other
variables remain constant, citrous paribus. The study suggests that bank of Abyssinia should
implement more policies to that will maintain the low levels of liquidity to serve as
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equilibrium between the motive for profit and the satisfaction of financial obligations of
customers. On the other side the policy maker, NBE has to consider the existing economic
conditions and promote favourable environment to the development of the financial sector.
Key Words: Ethiopian, Bank of Abyssinia, Auto regressive distributive lag (ARDL), Liquidity,
Time Series Data Regression Analysis.
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CHAPTER ONE
INTRODUCTION
1.1. Background of the Study

The capacity to cater for provision of funds by a legal agency or financial body at maturity
period is known as liquidity, which includes commitments, withdrawals, deposits, lending and
investment and accrued liabilities (Mori, 2013). Giving preference to liquidity definition,
liquidity management takes one of two types. One type of liquidity refers to the ability
monetarily exchange an asset at its existing price including bond and stocks. The other
meaning of liquidity applies to large organizations, such as banks. Financial institutions are
evaluated on their ability to meet cash and collateral responsibilities without incurring
substantial loss; they are also always evaluated on their liquidity (Drehmann and Nikolaou,
2010).
The liquidity of a bank is critically important for bank success. It is a “measure of bank’s
ability to find ready cash, short-term creditworthy securities, government bills, etc..., which
can be readily converted into cash” (Elliot, 2015, p. 11).
Banks ensure the transmission of funds from surplus to deficit areas and serve to meet the
demand of those who are in need. Banks facilitate spending and investment, which stimulate
growth in the economy (Douglas, 2014).
Liquidity for a Bank means the ability to meets its financial obligations as they come due,
without incurring unacceptable losses (BIS, 2008). Hence, liquidity risk arises from the
fundamental role of banks in the maturity transformation of short-term deposits into long-term
loans. Therefore, banks have to hold optimal level of liquidity that can maximize their profit
and enable them to meet their obligation. It includes two types of risk: funding liquidity risk
and market liquidity risk.
Funding liquidity risk is the risk that the bank were not be able to meet efficiently both
expected and unexpected current and future cash flow and collateral needs without affecting
either daily operations or the financial condition of the firm. Market liquidity risk is the risk
that a bank cannot easily offset or eliminate a position at the market price because of
inadequate market depth or market disruption.
According to Shershneva et.al. (2020), the basic scientific concept of liquidity in the bank is
the ability to ensure timely and complete performance of obligations to depositors, creditors
and other parties.
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According to Rahel, (2019) Liquidity for a bank means the ability of a financial institution to
meet all legitimate demands for funds. Failure to meet this obligation implies illiquid risk.
During global financial crisis, many banks struggled to maintain adequate liquidity. In order
to sustain the financial system, unprecedented levels of liquidity support were required from
central banks (Černohorský et al., 2010). Even with such extensive support, a number of
banks failed, were forced into mergers or required resolution (BIS, 2009; Teplý, 2011). The
crisis showed the importance of adequate liquidity risk measurement and management.
The global financial crisis revealed the importance of banks' liquidity positions, as several
significant private banks with severe liquidity problems filed for bankruptcy (Bhati, Zoysa, &
Jitaree, 2012). Liquidity concerns both investors and debtors (Diamond et al., 2015). Investors
may become less certain when there is little liquidity. Administrative authorities must resolve
certain bank liquidity breaking points in order to ensure investor confidence (Bagh, 2017).
Since the Covid-19 started to spread in 2020, Commercial banks was a crucial component in
the chain of liquidity transmission. Following this epidemic, undetected dangers related to
liquidity will undoubtedly become evident. Commercial banks and the entire financial system
were affected when the liquidity risk emerges.
The financial stability of financial institutions, especially those in the banking sector, might be
considered to be closely correlated with liquidity. Sekoni (2015) highlights that banks' growth
and development are emphasized since they guarantee the smooth operation of the financial
markets.
The ability of the bank to meet its obligations on schedule and avoid suffering any unforeseen
losses is known as liquidity. Given the foregoing, the topic of the factors influencing bank
liquidity has been the subject of extensive research to date. For example, research like Shen et
al. (2009) and Vodova (2011), as well as Rauch et al. (2009), have demonstrated that both
internal and external factors affect bank liquidity.
Generally speaking, banks aim to balance liquidity and profitability (Niresh, 2012). One
crucial aspect of banking is always providing clients with enough liquidity. In order to fulfil
withdrawal commitments and fresh loan demands from clients in need of liquidity, banks
make sure that there is an adequate supply of cash and other near-cash securities available.
There are several studies on the factor affecting bank liquidity conducted in different times
and at different countries
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Many banks in Africa have been holding large amounts of liquid assets (Freedman and Click,
2006) For instance, over the period 1990 and 2009, the ratio of liquid reserves to total assets
for the median bank in sub-Saharan Africa (SSA) has varied between 11% and 19%.
Laurine (2013) conducted studies on the determinants of banks liquidity risk in Zimbabwe.
The results confirmed that interest rate spreads have a positive influence on liquidity risk. In
Morocco, Ferrouhi & Lehadiri (2013) conducted a study which confirmed that liquidity is
mainly determined by foreign direct investment (FDI), monetary aggregate M3, GDP etc.
Moussa (2015) conducted a study on the determinants of banks liquidity in Tunisia. The
results confirmed that growth rate of GDP and inflation rate have a significant effect on banks
liquidity.
Modern banking in Ethiopia started in 1905 with the establishment of Abyssinian Bank which
was based on a fifty year agreement with the Anglo-Egyptian National Bank. In 1931 the
Ethiopian government purchased the Abyssinian Bank, which was the dominant bank, and
renamed it the Bank of Ethiopia i.e., the first nationally owned bank on the African continent
(Gedey 1990 and Geda 2006).
Currently, there are thirty banks both public-owned and private banks operating in the country
consisting of 8,250 branches, serving the country's population of nearly 115 million. The
National Bank of Ethiopia's (NBE) (2022) reports deposits equivalent to over $30 billion, and
loans equivalent to over $25 billion.
Among those private owned banks, the present-day Bank of Abyssinia was established on
February 15, 1996 (90 years to the day after the first but defunct private bank was established
in 1906 during Emperor Menelik II) in accordance with 1960 Ethiopian commercial code and
the Licensing and Supervision of Banking Business Proclamation No. 84/1994.
BOA started its operation with an authorized and paid up capital of Birr 50 million, and Birr
17.8 million respectively, and with only 131 shareholders and 32 staff. Currently, employing
the state-of-art banking technology, the Bank provides excellence domestic, international and
special banking services to its esteemed and valuable customers. Bank of Abyssinia (BOA)
has more than 11,283 staffs, 824 Branches and 9.3 million customers throughout the country.
In order to provide pertinent suggestions for current practice and add to the small body of
literature in the nation, the researchers were motivated by the situation—a lack of current
knowledge or research, or a gap—to investigate the determinant factors that affect the
liquidity status of Ethiopian banks.
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Due to the unexpected shock and grievous loss in financial institutions, absence of capital
markets; reviewing factors of liquidity is vital for better understanding on the concept of
liquidity. Moreover, the relationship between bank liquidity macro-and micro-economic
variables is not conclusively determined, as literature shows opposing view the direction and
significance of the variable under consideration. Therefore, the main aim of this study is to
investigate the factors of liquidity of Ethiopian banks, Bank of Abyssinia.
This study aims to conduct a Time-serious analysis to examine the effect of various bank-
specific Variables(Capital Adequacy, Loan growth, Profitability, Non-performing loan, No. of
branches & No. of ATM's) and macroeconomic variables(GDP, Inflation & Interest rate) on
Bank of Abyssinia factors of liquidity, covering a 25-year period starting from 1998. Section
1 provides a review of the prior studies examining the factors of liquidity in banks. Section 2
the research methodology. Section 3 presents the results and a discussion, and the final
section concludes.
1.2. Statement of the Problem

The fundamental role of a bank is to channel funds from surplus economic unit to deficit
economic units. They also provide a channel for policy makers to conduct monetary policies
that control the price and foreign exchange stability. However, the activity of the bank is not
without problems, since banks have fundamental role in the maturity transformation of short-
term deposits into long-term loans that inherently exposed for liquidity risk. In such
circumstance, banks has exposed to liquidity problem and may frustrate their costumers and
may affect the financial sector as a whole. On the other hand, when banks hold excess liquid
asset which are non-earning assets such as cash and non-interest bearing deposits, the bank’s
profitability were affected.
Such as, the liquidity risk of Islamic banks, which mainly takes the form of mismatch between
assets and liabilities, is, however, partly originated from the shortage of long-term funds. The
Islamic bank should create a right balance between the two objectives of safety and
profitability because maintaining too much liquidity hurts the profitability objective.
Surplus liquidity with Islamic banks cannot be easily transferred to conventional banks since
the Islamic banks do not accept interest; however there is room for exchange of surplus funds
among the Islamic banks especially when they are performing side by side with some other
Islamic banks.
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Hence, every bank has to ensure that it operates to satisfy its profitability target and at the
same time to meet the financial demands of its customers by maintaining optimum level of
liquidity.
Liquidity creation itself is seen as the primary source of economic welfare contribution by
banks but also as their primary source of risk (Bryant 1980 or Calomiris and Kahn 1991).
Banks are vulnerable to the risk of a run on deposits and transformation risk since they are
liquidity insurers. In general, banks are more likely to experience losses from having to sell
illiquid assets in order to satisfy consumer demands for liquidity if they create more liquidity
for the outside world. To prevent these kinds of losses, banks should constantly be positioned
to keep the ideal amount of liquid assets.
As per Asphachs et al. (2005), banks have three possible layers of insurance; a buffer of liquid
assets in bank‟ individual portfolios, unsecured lending/borrowing in the interbank market
and a lender of last resort/LOLR safety net. The first one is internal and the remaining two are
external sources of liquidity. Like the sources of their liquidity, the liquidity position of banks
can be affected by bank specific factors; Capital Adequacy, Loan growth, Profitability, Non-
performing loan, No. of branches & No. of ATM's) and macroeconomic variables (GDP,
Inflation & Interest rate).
However, the liquidity fragility is also a source of efficiency. Diamond and Rajan (2001)
argue that the financial intermediation structure is efficient in that it disciplines banks when
carrying out their lending function. The threat of a run is an incentive for the bank to choose
projects with high return. More generally, this also suggests that an “even more liquid” bank
might not always be desirable for the efficiency of the financial system. Therefore, 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 and to keep
their optimal profitability.
Likewise, Tseganesh (2012) stated that the liquidity risk is said to be assassin of banks. This
risk can adversely affect both bank’s earnings and the capital.
Therefore, it becomes the top priority of a bank’s management to ensure the availability of
sufficient funds to meet future demands of providers and borrowers, at reasonable costs.
Episodes of failure of many conventional banks from the past and the present provide the
testimony to this claim.
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Ethiopia’s financial sector is largely bank based as the secondary market is still not found in
the country. Banks dominate the financial sector in Ethiopia and as such the process of
financial intermediation in the country depends heavily on banks.
In fact the banking sector in Ethiopia is currently acts as the link that holds the country’s
economy together. Hence, keeping their optimal liquidity for banks in Ethiopia is very
important to meet the demand by their present and potential customers. Worku (2006)
“liquidity and its impact on performance of commercial banks in Ethiopia” and Semu (2010),
the impact of reducing or restricting loan disbursement on the performance of banks in
Ethiopia‟ are worth mentioning. In her study entitled „determinants of banks liquidity and
their impact on financial performance‟.
Nowadays most of the commercial banks in Ethiopia are facing liquidity problems. The study
will recognized this problem from different reports and measures. For instance, most of banks
terminate staff mortgage loan, Profitability, capital adequacy minimized offering loan for
customer or clients, even limited the amount of withdrawal from deposits. Besides this
currently banks in Ethiopia has facing uncontrolled monitory circulations and unstable
liquidity.
For the knowledge of researcher, the first study in the area was conducted by (Tseganesh,
2012), analysed both bank specific and macroeconomic variables from year 2000 to 2011 for
the sampled commercial banks, Berhanu (2015) conducted study on Determinants of Banks
Liquidity and their Impact on Profitability Evidenced from eight commercial banks in
Ethiopia, Nigist (2015) studied Determinants of Banks Liquidity: Empirical Evidence on
Ethiopian Commercial Banks with aims to investigate the determinants of commercial banks
liquidity in Ethiopia and Belete (2015) have studied the internal and external factors that
affect Ethiopian commercial banks liquidity. On the other hand Alemayehu (2016) on
Determinants of Bank Liquidity of Commercial Banks of Ethiopia over the period of 2002 to
2013 and Rahel (2019) have tries to identify the impact of some bank-specific and
macroeconomic variables of Ethiopian banks liquidity. Without hesitation financial
institutions liquidity is utterly crucial to the economic excellence of the country. Previous
literatures conducted on factors of liquidity in Ethiopian banks did, t shown clearly.
Private Banks in Ethiopia are now facing severe liquidity & the problem still continues. This
makes the researcher interested to find the factors of liquidity problem. On the other hand, in
Ethiopia studies in relation to factors affecting banking industry’s liquidity considering both
internal and external factors are very scanty. In general, the lack of sufficient research on the
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factors affecting bank liquidity in the context of Ethiopia and the existence of knowledge gap
in the area was initiated this study.
Therefore, this study seeks to fill the gap by providing full information about the internal and
external factors that affects Ethiopian Private Bank , s, Bank of Abyssinia liquidity by
incorporating the untouched ones.
Thus, in ordered to fulfil the above gap this study will be conducted on factor affecting
liquidity of Bank of Abyssinia in Ethiopia including the variables such as Profitability,
Capital adequacy, number of branches, Non-performing loan, number of ATM, loan growth,
Interest rate, economic growth(GDP) and inflation. By recognized this gap the study would
interest to find out the major factor that affects liquidity positively or negatively by using time
series data analysis.
1.3. Objectives of the Study

The general objective of this study is to find the factors that affect liquidity of Bank of
Abyssinia in Ethiopia.
The specific objectives

 To investigate internal and external factors that affect liquidity of bank of Abyssinia
 To examine the trends of liquidity assets holding by the bank
 To Determine major factors that have a significant impact on liquidity
1.4. Research Question

In line with its objectives, the following questions are addressed in this study.
 What are the internal and external factors that affect liquidity of bank of Abyssinia?
 How was the trends of liquidity of bank of Abyssinia for the last 26 years?
 What are the major factors significantly affecting liquidity of bank of Abyssinia?
1.5. Significance of the Study

The study identified the factors that have a substantial impact on bank liquidity and came to certain
findings. It contribute to the existing knowledge in the areas of factors affecting banks liquidity. It
also produce liquidity policy and to give due attention on those factors which have significant
impact on bank’s liquidity. As a result, it signals to bank management and policy makers when
corrective action is needed. It is anticipated that it could play a role in promoting the health of the
financial industry, the economy, and society at large. Academicians and researchers would find
this work helpful because there isn't much research on the topic in the Ethiopian environment. As a
result, the study broadens our understanding of the topic.
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1.6. Scope of the Study
This study scope had outlined in connection to its goal and a few theoretical and practical
difficulties. Since the goal of this study is to determine the factors influencing the liquidity of
Bank of Abyssinia’s financial performance in Ethiopia by incorporating both internal and
external variables by covering a 26- year period(1998-2023).
As a result, the study scope is restricted to bank of Abyssinia. Theoretically, it took into
account standard features of liquidity and related variables, along with the methods that has
applied in their definition and assessment.
1.7. Limitation of the Study

As stated in the objective, the goal of this research is to determine the primary factors
influencing banks' liquidity within the study region. The investigation of liquidity as gather
and reflected by the data available for the variables. Data from yearly reports were used to
determine the significant variable at the bank level. The researcher is limited on Bank of
Abyssinia and its statistical figures for liquidity and explanatory variables. Its consideration of
only one private bank results in another spatial limitation. As a result, not able to conclude all
private banks have enough liquidity. The aforementioned limitations must be considered in
order to fully comprehend the study finding.
1.8. Organization of the Study

The study is divided into five chapters in order to evaluate factors affecting the liquidity of
Bank of Abyssinia (BOA). The first part of the dissertation is discussing the background,
problem statement, objectives, question, the significance, scope, limitations and organization
of the thesis. The second chapter reviews the most significant theoretical and empirical
studies. The empirical studies part presents various related researches and their results.
The third part of the study would discuss the methods and procedures being used in the study.
The chapter comprise of the presentation of the utilized techniques for data collection and
research methodology. Similarly, it also contains a discussion on the techniques used in data
analysis as well as the tools used to acquire the data.
The fourth chapter devotes the discussion of the results of the study. Data would be presented
and analysed by time series Model. The final chapter presents conclusion and
recommendations and at the end references and appendixes were attached.
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1.9. Ethical Considerations
Research ethics deal with concerns of how the research topic is constructed and defined,
research is designed, data is accessed and collected, data is processed and stored, data is
analysed and presentation of research findings in an honest and accountable fashion (Saunders
et al., 2009, p. 184).
Therefore, the researcher committed to research ethics will anticipate the probable impact of
the research on the participants and pro-actively deal with the concerns (Macintosh et al.,
2015, p. 197). The researcher had got available information and performed contextual analysis
to ensure correct presentation of facts as per available information (Greener, 2008, p. 43).
The banks comprising our target sample have had their identity withheld because it is not
pertinent to the results of this study and also due to lack of interaction between the researchers
and the participant banks as secondary data was relied upon (Greener, 2008, p. 44). Since this
study relied on secondary data extracted from publicly available information, the concept of
informed consent is not abrogated as the information has been freely issued by the participant
banks vis-à-vis annual reports and other statutory reports. The researchers of this study are
also careful not to deceive in any way when using the collected data as the study is purely for
an academic purpose though with practical relevance (Walliman, 2011, p. 48).
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CHAPTER TWO
LITERATURES REVIEW
2.1. Concepts of Banks Liquidity

Liquidity of banks means the capability of a bank to meet its obligations due at any time,
especially to repay customer deposits or to make a payment on the client's order (Vodova,
2016). To describe liquidity determinants of banks, there are two most widely used
approaches; liquidity gap approach (flow approach) and liquidity ratio approach (stock
approach). Though both approaches are intensively applying liquidity of banks. The liquidity
ratio approaches are more common in practice due to the availability of a more standardized
method (Edom, 2017; Laurine, 2013).
The most popular stock ratios which are used in different studies, for example, the study of
Vodova (2012), employed two most convenient liquidity measures ; oan to deposit ratio and a
liquidity asset to deposit ratio. Liquid asset to deposit ratio which indicates the extent to
which the bank's total liquid assets are composed of deposits from customers and other
financial institutions, and loan to deposit ratio which signposts what proportion of the
explosive money of the bank is concentrated in loans which are illiquid, and liquid asset to
total asset ratio which gives information about the long - term liquidity shock absorption
ability of a bank.
Liquidity is another factor that determines the level of bank performance. Liquidity refers to
the ability of the bank to fulfil its obligations, mainly of depositors. According to Dang (2011)
adequate level of liquidity is positively related to bank profitability and the most common
financial ratios that reflect the liquidity position of a bank are customer deposit to total asset
and total loan to customer deposits. Other scholars use different financial ratio to measure
liquidity. For instance, Ilhomovich (2009) used cash to deposit ratio to measure the liquidity
level of banks in Malaysia. Liquidity can be defined as the ability of a financial institution to
meet all legitimate demands for funds (Yeager, 1989). According to (Zewadi, 2013) Liquidity
indicates the ability of the bank to meet its financial obligations in a timely and effective
manner.
As per Douglas, (2014) liquidity at a bank is a measure of its ability to readily find the cash it
may need to meet demands upon it. Liquidity can come from direct cash holdings in currency
or on account at the Federal Reserve or other central bank. More commonly it comes from
holding securities that can be sold quickly with minimal loss. This typically means highly
creditworthy securities, including government bills, which have short-term maturities.
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In the portfolios of commercial banks, liquid assets play a very vital role since the banks
operate mainly with the funds borrowed from depositors in either forms of demand and time
deposits. In view of the fact that these deposits represent the obligations of the banks to be
paid whenever they are requested, the banks should always allocate their funds in such a way
that their portfolios should always contain an adequate level of liquid assets.
2.2. What is liquidity at a bank?

According to (Zewadi, 2013) Liquidity indicates the ability of the bank to meet its financial
obligations in a timely and effective manner. There should be adequacy of liquidity sources
compared to present and future needs, and availability of assets readily convertible to cash
without undue loss.
Liquid assets are those that can be converted to cash quickly if needed to meet financial
obligations; examples of liquid assets generally include cash, deposit in central bank or to
other banks and government debt (Alemayehu, 2016).
According to business dictionary, liquidity is a measure of the extent to which a person or

organization has cash to meet immediate and short-term obligation or assets that can be
quickly converted to do this. Liquidity can also be measure of the ability and ease with which
assets can be converted to cash. Liquid assets are those that can be converted to cash quickly
if needed to meet financial obligations; examples of liquid assets generally include cash,
central bank reserve and government debt. To remain viable, a financial institution must have
enough liquid assets to meet its short term obligations, such as withdrawals by depositors.
The transformations of liquid liabilities (deposit) in to risky liquid (illiquid) assets in the form
of loans capitalizing on their maturity mismatch expose them to liquidity risk (Diamond and
Dybving, 1983: Jeinson, 2008)
2.3. Sources of Bank’s Liquidity

According to Rochet (2008), the three sources of liquidity risk are; on the liability side, there
is a large uncertainty on the volume of withdrawals of deposits or the rolled-over of inter-
bank loans, on the asset side, there is an uncertainty on the volume of new requests for loans
that a bank will receive in the future, and off-balance sheet items, like credit lines and other
commitments taken by the bank.
Financial institution can mobilizes resources through new deposits, maturing assets, borrowed
funds and/or using the discount window (borrowing from the central bank). However,
financial institution may encounter liquidity risk.
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Some of the mechanisms to insure liquidity crises are: banks hold buffer of liquid assets on
the asset side of the balance sheet such as cash, balances with central banks and other banks,
debt securities issued by governments and similar securities or reverse repo trades reduce the
probability that liquidity demands threaten the viability of the bank. The second strategy is,
banks can rely on the interbank market where they borrow from other banks in case of
liquidity demand. The last strategy is that, the central bank typically acts as a Lender of Last
Resort/LOLR to provide emergency liquidity assistance to particular illiquid institutions and
to provide aggregate liquidity in case of a system-wide shortage (Aspachs et. al, 2005;
Tiesset, 2005).
2.4. Factors Affecting Liquidity

2.4.1. Bank specific factors affecting Liquidity
Capital adequacy: capital is one of the factors that significantly affect bank liquidity
Mazreku, et al (2019). It comprises paid-up capital, undistributed profit (retained earnings),
legal reserve or other reserves and surplus fund that are kept aside for contingencies. Recent
theories suggest that, bank capital may also affect bank's ability to create liquidity.
Furthermore, John G., Phil & John O., (2004) show that a higher capital ratio may reduce
liquidity creation through another effect: “the crowding out of deposits”. They consider that
deposits are more effective liquidity hedges for agents than investments in bank equity.
Loan growth and bank liquidity: The loans and advances portfolio is the largest asset and
the predominate source of revenue of banks. According to (Diamond and Rajan, 2005),
lending is the principal business activity for banks. Since loans are illiquid assets, increase in
the amount of loans means increase in illiquid assets in the asset portfolio of a bank. The
amount of liquidity held by banks is heavily influenced by loan demand and it is the base for
loan growth (Pilbeam, K, 2005). If demand for loans is weak, then the bank tends to hold
more liquid assets whereas, if demand for loans is high they tend to hold less liquid assets
since long term loans are generally more profitable. Therefore, loan growth has negative
relationship with bank liquidity.
Branch Expansion and bank liquidity: Branch Expansion is one of the strategies at
different location of home country as well as opening of multinational banks at home country.
Branch expansion is opening new branches or service outlets inside and outside the country
(Carlson and Mitchener, 2005). Commercial banks in Ethiopia expend huge investment
budget for branch expansion in and outside Addis Ababa yearly, because branch expansion
play significant role for resource mobilization and customer attraction.
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Opening bank branches at different locations facilitate for proximity to customers, supports
the bank mobilize deposit and attract more customers. However, before opening branch at a
certain location the marketing department of a bank conducts feasibility study and identify the
target market. Then assignment of employees and customer attraction endeavour will take
place. Therefore branch expansion to banks is very crucial with regard to deposit mobilization
and customer attraction.
Profitability and bank liquidity: Profitability accounts for the impact of better financial
soundness on bank risk bearing capacity and on their ability to perform liquidity
transformation (Rauch, C, Steffen, S, Hackethal, 2008). A sound and profitable banking
sector is better able to withstand negative shocks and contribute to the stability of the financial
system (Athanasoglou et. al, 2005). One of the highest yielding assets of a bank is loans and
advances that provide the largest portion of operating revenue. In this respect, banks are faced
with liquidity risk since loans and advances are funds from deposit of customers. The higher
the volume of loans and advances extended to customers, the higher the interest income and
highest profit potentials for banks but it affects liquidity of the bank. Thus, banks need to
strike a balance between liquidity and profitability.
2.4.2 Macro-economic Factor

The expansion of commercial banks' deposit mobilization is influenced by macroeconomic
conditions. Macroeconomics, as the name suggests, examines the larger picture. The study of
the whole economy, including its economic systems, is known as macroeconomics. It takes
into account a number of broad economic aggregates, including the GDP, employment,
unemployment, inflation, interest rates, and foreign trade. The legal and economic framework
that influences bank operations and deposit holdings is reflected in the macroeconomic
determinant variables. Factors that can affect bank's deposit include but not limited to growth
of the population, deposit, interest rate, economic growth, and disposable income, among
others (Thomas J.Webster, @2003).
Economic Growth and bank liquidity: Economic growth is an economy that determines the
increase or development of production of goods and services from time to time. It is usually
measured on the basis gross domestic product (GDP) as stated by yanne et al. (2007). Some
literature generated a mixed view regarding the relationship between savings and economic
growth. Other researches explain that savings cause to economic growth; however some other
argue that economic growth are greater causes of savings. Different countries also have
different effect of saving; income source of a country play an important role in determining
banks financial performance and generation of income.
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In the light of life-cycle analysis, GDP growth will result in an increase of aggregate savings,
because saving increases the lifetime earnings and savings of younger age groups relative to
older age groups (A thukorala and sen, 2004). Thus, countries with higher GDP growth rates
are expected to have higher savings than countries with lower growth rates. Hence, growth
domestic product (GDP) has significant positive contribution to saving rate or deposit rate.
However, the size of this effect is likely to decline as GDP growth raises and even become
negative for rich countries where high return on investment than deposit interest income are
available (Epaphera, 2014).
Inflation and bank liquidity: inflation is the general increase in price levels. The impact of
inflation rate on bank liquidity has been a subject of debate in previous literature. Some
authors imply that an increase of the inflation rate will lower the purchasing power of
individuals, who will then need more money to buy the same products. As a result, the
demand for loans will increase and thus, bank liquidity will decrease (Trenca, Petria &
Corovei, 2015).
Disposable income: Although disposable income is considered as income net of tax, it is

divided in to three major types by households: - that is tax, consumable, and savings. Income
after tax is disposable income. Household disposable income is therefore the income available
to household for consumption or saving. The life-cycle hypothesis suggests a positive
relationship between saving and income. High incomes improve the per capita income of the
households, which will induce them to save more (Epaphra, 2014).
Changes in the real disposable income over time are often interpreted as a measure of changes
in the average standard of living of the country. If households and firms desire to hold more
money, deposits will increase. So the relationship between income and deposits is positive: -
that is as the income of the society increases the same happens for the commercial bank's
deposits. Income is expected to have a positive effect on deposits (Khaliy, Meyer & Hushak,
1987).
Interest rate spread and bank liquidity : Interest rate is one of the deposit attraction
techniques used by commercial banks to get more deposits from the surplus sector is by
providing attractive interest payment on savings, and which is reasonable and acceptable to
the owner of the money. The dynamic economic situation and the shift of depositors to risky
investment to earn higher profit derived commercial banks to device alternative strategies to
improve their deposits because, the type of bank, type of interest-bearing account and deposit
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balance can play a significant role in saving rates. Offering higher interest rate on saving
attract customers to return back to banks.
Saving account deposits that earn a higher saving interest rate will grow at a faster pace.
However, excessive interest rate is a danger to commercial bank than benefits. Hence banks in
some countries require account holders privileged to higher rate to six-withdrawal limit per
month. On the other hand, online savings account usually offer higher saving rates because
online banks have lower expense because they do not need to maintain more branches at
different customer locations. Saving rate can also differ by account balance. More deposits
may qualify for a higher savings rate. Khalayi, ondiek, and Musiega (2014) said “in order to
mobilize savings on large scale, affirms that cooperatives must offer interest rate that is
attractive to savers.
2.5. Empirical literature on factors of liquidity

This section gives a brief review of the previous studies made on the determinants/factors of
bank’s liquidity for different nations. Moreover, most of the studies undertaken on bank
liquidity consider both bank specific and macroeconomic factors to examine the determinants
of liquidity of banks. So, the studies conducted in related to bank’s liquidity are reviewed as
follows.
2.5.1. Review of International empirical Literatures
El- Chaarani, (2019) examined the determinants of bank liquidity in the Middle East region.
He used two different liquidity measures, four bank specific factors and three macro-
economic factors of 183 banks from eight different countries during a period of 3 years (2014,
2015 and 2016). The research considered "loans-to-assets" and "loans to deposit" as proxies to
measure the bank's liquidity level; assets quality, performance level, capitalization ratio and
bank size as the bank specific factors; and economic growth, unemployment and inflation
rates as the macro economic factors. The results indicate that Lebanese banks has the highest
level of liquidity whereas Omani banks has the lowest level of liquidity. In addition, the study
shows a decreasing of bank liquidity during 2016 in Middle Eastern countries.
Sopan and Dutta (2018) explored the bank-specific and macroeconomic determinants of
Indian banks’ liquidity risk. The result revealed that size, profitability level, funding cost,
asset quality, and GDP growth rate had a significant negative impact on banks’ liquidity risk,
whereas the rate of deposits, capitalization rate, and inflation rate had a positive effect on
banks’ liquidity. Gautam (2016) also examined the determinants of Nepalese commercial
banks liquidity and his finding revealed that capital adequacy has a positive statistically
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significant impact on banks liquidity, while non-performing loans and profitability had a
negative statistically significant impact on the banks’ liquidity.
Mohamad (2016) examined financial data of 21 Turkish banks over the period of 2006-2013.
He took two liquidity ratios i.e. the ratio of liquidity asset to customer deposits and short-term
funding (first ratio), and the ratio of liquid assets to total deposits (second ratio) and
determinant factors of bank specific, macroeconomic variables and global financial crisis. He
reported that only bank capitalization has positive and statistically significant impact on both
liquidity ratios, while loan loss reserve ratios has positive and statistically significance impact
on the first ratio, and bank size has negative and statistically significant impact on the same
ratio. On the other hand, bank profitability has negative and statistically significant impact on
the second liquidity ration. The results of both regression tests revealed that macroeconomic
indicators and the crisis dummy variable have non-significant relations with both liquidity
ratios.
Moussa (2015) took a sample of 18 banks in Tunisia in for 2000 - 2010 period. He estimated
two measures of liquidity (liquid asset) / total asset; total loan / total deposits). Using the
method of static panel and method of panel dynamic, he found that (financial performance,
capital / total assets, operating costs/ total assets, growth rate of GDP, inflation rate, delayed
liquidity) have significant impact on bank liquidity while ( size, total loans / total assets,
financial costs/ total credits, total deposits / total assets) does not have a significant impact on
bank liquidity.
Ferrouhi and Lehadiri (2013) studied liquidity determinants of Moroccan Banking Industry
using data over the period 2001 – 2012 with the aims to analyze the evolution of bank's
liquidity in Moroccan banks and to explain the impact of the financial crisis on bank's
liquidity in Morocco. Results show that in Morocco, liquidity is mainly determined by eleven
11 determinants: size of banks, share of own bank's capital of the bank's total assets, external
funding to total liabilities, return on assets, foreign direct investment, monetary aggregate M3,
foreign assets, growth rate of gross domestic product, public deficit, inflation ratio and the
effects of financial crisis. Thus, liquidity of Moroccan banking industry is positively
correlated with bank's size, share of own bank's capital of the bank's total assets, external
funding to total liabilities, monetary aggregate M3, foreign assets, foreign direct investment
and negatively correlated with return on assets, inflation rate, growth rate of gross domestic
product, public deficit and financial crisis. However, bank's returns on equity, equity to total
assets and unemployment rate have no impact on Moroccan bank's liquidity.
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Wilber Chagwiza (2011) made a study on Zimbabwe, regarding the commercial banks
liquidity and its determinants. The main objective of his study was to identify the
determinants of liquidity in Zimbabwean commercial banks. The data cover the period from
2010 to 2011. He uses regression analysis and his study revealed that higher bank's capital,
total assets volume, higher lending rates, and positive country's GDP increases the bank's
liquidity in Zimbabwe.
In other words, there is a positive link between bank liquidity and capital adequacy, total asset
volumes, gross domestic product and interest rate. In other way the study revealed the
adoption of multi-currency, inflation rate and business cycle have a negative impact on
liquidity. It seems the banks size and their liquidity is positively correlated and the most
recent studies made by Laurine (2013) again in Zimbabwe regarding Zimbabwean
Commercial Banks Liquidity Risk Determinants after Dollarization. The aim of his paper was
that empirically investigating the determinants of Zimbabwean commercial banks liquidity
risk after the country adopted the use of multiple currencies exchange rate system and to
attain the intended objective panel data regression analysis was used on monthly data from the
period of March 2009 to December 2012. The result of the study revealed that capital
adequacy and size have negative and significant influence on liquidity risk whereas spread;
non-performing loans have a positive and significant relationship with liquidity risk. Reserve
requirement ratios and inflation were also significant in explaining liquidity during the studied
period.
Fadare (2011), on the banking sector liquidity and financial crisis in Nigeria with the aim of
identifying the key determinants of banking liquidity in Nigeria, and assessing the relationship
between determinants of banking liquidity and financial frictions within the economy. It was
employed a linear least square model and time series data from 1980 to 2009. The study found
that only liquidity ratio, monetary policy rate and lagged loan to deposit ratio were significant
for predicting banking sector liquidity. Secondly, it showed that a decrease in monetary policy
rate, liquidity ratios, volatility of output in relation to trend output, and the demand for cash,
leads to an increase in current loan to deposit ratios; while a decrease in currency in
circulation in proportion to banking sector deposits; and lagged loan to deposit ratios leads to
a decline in current loan to deposit ratios. Generally, the result suggested that during periods
of economic or financial crises, deposit money banks were significantly illiquid relative to
benchmarks, and getting liquidity monetary policies right during these periods is crucial in
ensuring the survival of the banking sector
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Moore (2010) investigated the effects of the financial crisis on the liquidity of commercial
banks in Latin America and Caribbean countries. The study had three main goals: discussing
the behaviour of commercial bank liquidity during crises in Latin America and the Caribbean;
identifying the key determinants of liquidity, and; to provide an assessment of whether
commercial bank liquidity during crises is higher or lower than what is consistent with
economic fundamentals.
Liquidity which was measured by loan-to-deposit ratio should depend on: cash requirements
of customers, captured by fluctuations in the cash-to-deposit ratio expected to have negative
impact, the macroeconomic situation, where a cyclical downturn should lower banks'
expected transactions demand for money and therefore lead to decreased liquidity expected to
have positive impact on liquidity, and money market/short term interest rate as a measure of
opportunity costs of holding liquidity expected to have negative effect on liquidity.
Samy & Mohammed (2008) also examine the influence of bank regulations, concentration,
financial and institutional development on commercial bank margin and profitability across a
broad menu of Middle East and North Africa (MENA) countries. They cover period from
1989 to 2005 and control for a wide array of macroeconomic, financial and bank
characteristics. This study find the regulatory variable ( reserve requirement and coverage to
deposit to capital ratio) and institutional variable (concentration) seem to have an impact on
bank performance as the results suggest that corruption increases the cost efficiency and net
interest margins while an improvement of the law and order variable decreases the cost of
efficiency without affecting performance.
Entirely unique is the approach of (Fielding and Shortland 2005). The researchers estimated a
time-series model of excess liquidity in the Egyptian banking sector. They considered these
determinants of liquidity: level of economic output, discount rate, rate of depreciation of the
black market exchange rate and violent political incidence expected to have positive impact
on bank liquidity whereas, cash-to-deposit ratio and impact of economic reform expected to
have negative impact on bank liquidity. The expected impact of reserve requirements was
ambiguous. According to the result of the study while financial liberalization and financial
stability are found to have reduced excess liquidity, these effects have been offset by an
increase in the number of violent political incidents arising from conflict between radical
Islamic groups and the Egyptian state.
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2.5.2. Review of Ethiopian Empirical literatures
To the best of the researcher's knowledge, not many studies have attempted to offer insight
into the elements that determine a bank's liquidity, which are primarily related to
macroeconomic and bank-specific aspects in the publicly and privately owned banks that now
exist.
Eden (2014) examines the impact of NBE regulations on private banks performance through
the significant regulatory variables explaining the NBE directives, using bank-specific and
macroeconomic variables as control variables. Balanced fixed effect panel regression was
used for the data of six private commercial banks in the sample covered the period from 2004-
2013. The results of panel data regression analysis showed that NBE Bill and Credit cap had
negative and statistically significant impact on banks profitability but reserve requirement had
negative and insignificant impact on profitability. While measuring banks cost of
intermediation through Net Interest Margin three of the regulatory variables (i.e. NBE Bills,
Reserve requirement and credit cap) had negative and statistically significant effect on net
interest margin.
Rahel (2019) have tries to identify the impact of some bank-specific and macroeconomic
variables of Ethiopian banks liquidity for the data covering from 2000-2017 GC for the
sample of selected six private commercial banks. Liquidity creation is the main concerns of
commercial banks because banks are mainly involved in deposit mobilizing and lending
which have direct impact on their liquidity. Reserve Requirement (RR), Loan Growth (LG),
Capital Adequacy (CAR) and NBE Bill Purchase (BILL) have negative and statistically
significant impact on the determination of liquidity of Ethiopian selected private commercial
banks. Liquidity is negatively influenced also by the interest rate spread. The factors lead to
higher lending activity of banks and thus reduce bank liquidity. Size of the Bank (SB) had
negative and statistically significant impact on Ethiopian banks liquidity. GDP Growth rate
has negative impact on the liquidity of private commercial banks but it is statistically
insignificant.
Study conducted by Alemayehu (2016) on, Determinants of Bank Liquidity of Commercial

Banks of Ethiopia‟ over the period of 2002 to 2013 with main objective of determining the
factors that affect the liquidity of commercial banks in Ethiopia through employing 8
explanatory variables such as capital adequacy, bank size, profitability, Non-Performing
Loans (NPLs), loan growth, Gross Domestic Product (GDP) growth, inflation rate and
national bank bills (used as dummy variable) and he found that capital adequacy and
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profitability had positively significant impact, and loan growth rate and NBE-bill had
negatively significant effect on liquidity of commercial banks in Ethiopia. Whereas inflation
rate, NPLs, bank size and GDP growth were factors that have little or no impact on the
liquidity of Ethiopian commercial banks.
Belete (2015) examines the bank-specific and macro-economic factors affecting bank
liquidity for the sample of eight commercial banks in Ethiopia for the data cover over the
period of 2002-2013 by using balanced fixed effect panel regression. Unlike other researchers
in the area studied determinants of commercial banks liquidity in Ethiopia, he adopted a
mixed methods research approach (secondary and primary data) by combining documentary
analysis and in-depth interviews with selected banks‟ finance managers.
The result showed a negative relationship between loan growth and liquidity with strong
statistical significance in case of L1 (liquid assets to total deposits) which is as expected,
indicating that the increase in loans provided by banks lead to the reduction of the level of
liquid assets held by banks. In accordance with expectation of study, capital adequacy and
inflation showed positive and significant relationship with banks liquidity measured by L1.
The positive influence of the share of capital on total assets is consistent with the assumption
that bank with sufficient capital adequacy should be liquid, too. The positive and statistically
significant impact of inflation was based on the argument stating that in the inflationary
economy, economic units including banks refraining from long term investments due to the
decline in the real value of their investments that aggravate the credit market rationing and
prefer to hold risk free/liquid assets.
Berhanu (2015) conducted study on “Determinants of Banks Liquidity and their Impact on
Profitability: Evidenced from eight commercial banks in Ethiopia” with objective to identify
the internal (non-performing loans in the total volume of loans, capital adequacy, bank size,
loan growth, interest rate on bank lending and actual reserve ratio) and external (GDP growth,
inflation rate, interest rate margin and monetary policy) factors that affect Commercial banks
Liquidity and to assess their impact on Profitability. He used secondary source of data over
the period of 2002/03-2013/14 and analyzed them with panel data regression model. The
results of regression analysis showed that Bank size and Loan growth had negative and
statistically significant impact on banks liquidity measured by Liquid asset to total Asset. Real
growth rate of gross domestic product on the basis price level, Interest rate on lending ,Non-
performing loans in the total volume of loans, Bank size, Actual reserve ration and short term
interest rate had positive and statistically.
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Nigist (2015) studied “Determinants of Banks Liquidity: Empirical Evidence on Ethiopian
Commercial Banks” with aims to investigate the determinants of commercial banks liquidity
in Ethiopia. Secondary data of ten sampled commercial banks in Ethiopia over the period of
2007- 2013 used. Both bank specific and macroeconomic variables were analyzed by
employing the balanced panel fixed effect regression model. The result of the study revealed
that capital adequacy, profitability, and real GDP growth rate have negative and statistically
significant impacts on liquidity of Ethiopian commercial banks while bank size has positive
and statistically significant impact on liquidity. Whereas non-performing loan, loan growth,
inflation rate, and interest rate margin were found to be statistically insignificant/ has no any
impact on liquidity of Ethiopian commercial banks for the tested period.
Tseganesh (2012) studied Determinants of Banks Liquidity and their Impact on Financial
Performance: empirical study on commercial banks in Ethiopia aimed to identify determinants
of commercial banks liquidity in Ethiopia and then to see the impact of banks liquidity up on
financial performance through the significant variables explaining liquidity. Eight factors
affecting banks liquidity were selected and analyzed over the data 2000-2011 of eight
sampled commercial banks in Ethiopia by using balanced fixed effect panel regression.
2.6. Research Gap and Justification of this Paper

According to above theoretical as well as empirical review, liquidity is important to all
business specially for banking industry since it plays vital role of liquidity creation. “Liquidity
creation” refers to the fact that banks provide illiquid loans to borrowers while giving
depositors the ability to withdraw funds at par value at a moment’s notice (Diamond and
Dybvig, 1983). This chapter also revealed that banks liquidity can be affected by different
factors such as bank specific, macroeconomic and regulatory factors. Accordingly, this study
focused on some of the bank specific and macroeconomic factors affecting Ethiopian
Abyssinia bank, s liquidity.
Alemayehu (2016) like Nigist (2015) made a study on the significant factors which explain
the Ethiopians commercial bank liquidity by using panel data for the sample of eight
commercial banks in Ethiopia from 2002 to 2013 year and estimated using Fixed Effect
Model (FEM) and the study revealed capital strength and profitability had statistically
significant and positive relationship with banks‟ liquidity. On the other hand, loan growth and
national bank bill had a negative and statistically significant relationship with banks‟
liquidity. However, the relationship for inflation, non-performing loans, bank size and gross
domestic product were found to be statistically insignificant.
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As it was discussed in the literature review part, liquidity of banks can be affected by internal
and macroeconomic factors. Thus it is important to identify the factors of liquidity on
Ethiopian Abyssinia bank. Therefore, the objective of the study is to determine the factors that
affect bank liquidity in Ethiopia and fill the knowledge gap by employing additional variables
in the model in one private bank, bank of Abyssinia and adopting a time series method using
secondary data (NBE Annual report and BOA Annual reports) by Auto regressive distributive
lag (ARDL) regression analysis.
2.7. Conceptual frame works

The conceptual framework helps to clearly show the variables that are used in the study and
how they are connected. The conceptual framework portrays both bank-specific and
macroeconomic variables used. Based on the reviews made on the issue as well as the basic
questions of the research the following framework is developing in this study. The overlaps of
the circles supposed to indicate the degree of influence of the variables. It is also supposed
that bank specific, industry related and macro-economic factors affecting liquidity might not
be exclusive each other practically and theoretically.
After I reviewed both theoretical literature and empirical literature, conceptual framework of
the study was developed. Conceptual framework is an abstract representation of the study and
used to give comprehensive on the field of the study. The purpose of this section is to provide
a brief and generalized literature reviewed above, from the theoretical literature and empirical
literature there are different factor that determine liquidity are identified, such as market size,
human capital, economic development and macroeconomic stability. This study identified the
flowing variables such as Interest rate, economic growth, Profitability, number of branches,
loan growth, , number of ATM and inflation as determinant of liquidity.
Moreover, these variables are expected to affect liquidity directly or indirectly. For instance
variable like are Profitability, number of branches, loan growth and economic growth has a
direct effect on banks liquidity, but number of ATM, Interest rate, capital adequacy and
inflation is an indirect effect on liquidity.
Figure 2.1: Conceptual framework factors affecting liquidity
Macroeconomic
Bank-specific Variables
Variables Page | 22
 Inflation  capital adequacy
 GDP Liquidity  Non-performing loans
 Interest rate  Profitability
 loan growth
CHAPTER THREE
RESEARCH METHODOLOGY
3. Introduction
The methods used in assembling data and information for this research is shown and justified
in this chapter. This stage is about how research was executed and how the research was
completed. Therefore in this section the research identifies the procedures and techniques
used in collection, processing, and analysis of data. Specifically, the following subsections are
included; research design, source, collection, and type of data and data analysis method.
3.1 Research Design

Research design is defined as a framework of methods and techniques chosen by a researcher
to combine various components of research in a reasonably logical manner so that the
research problem is efficiently handled. It provides insights about “how” to conduct research
using a particular methodology. The research design provides an important framework and
guidelines on how to collect and analyse data. It also helped the researcher to answer the
research questions and to satisfy the research objectives. Therefore, it is a paramount to
properly define and evaluate the research design before conducting the research. According to
(Creswell, 2009), there are three basic research approaches; these are quantitative, qualitative
and mixed research approaches. The quantitative research approach relies on the measurement
and analysis of statistical data to produce quantifiable conclusions. Quantitative research is a
means for testing objective theories by examining the relationship among variables (Creswell,
2009).
Page | 23
The study is used explanatory research design. According to Muranaga and Ohsawa(2002), an
explanatory types of research design is important for a research types if the dependent
variable affected by several independent variables. Based on this liquidity can be affected by
several determinate factors. While the explanatory part of the study designed to use
correlation as well as multiple regression analysis.
3.2 Data Type, Sources and Collection

The study mainly used secondary time series data. The time series data of the variables for the
period (1998 to 2023) were used. In doing so, the data are obtained from annual financial
reports of Bank of Abyssinia, NBE report, and NBE web resources that used to investigate the
relationship between dependent and independent variables.
3.3 Sampling Design and Technique
A population is defined as an entire group of individual or objects having common observable

characteristic. The targeted population of this study is Bank of Abyssinia in the whole part of
Ethiopia. Bank of Abyssinia was incorporated as a share company on February 1996 with
licensing and supervision of banking business proclamation no. 84/1994.
The bank obtained a banking services license from national bank of Ethiopia and is registered
with the trade, industry and tourism bureau of the Addis Ababa city administration.
Sampling design: The sampling technique used under this study was non-random purposive or
judgmental sampling. In this type of sampling, items for the samples are selected deliberately;
the researcher choice concerning the items remains supreme.
3.4 Data Analysis Method
This study applied both the descriptive and econometric analysis methods. Trends of liquidity
and independent variables were analysed using the descriptive technique (i.e. comparison
among various trends analyze using statistical tools such as mean, median, etc.). Moreover,
tables, graphs and charts were incorporated in order to analyse the overall trends of liquidity.
furthermore, the Auto Regressive Distributed Lag (ARDL) co-integration technique
developed by Pesaran and Shin (1999) and Pesaran et al. (2001) is employed as an
econometric analysis method so as to indicate whether causalities exist between the
independent variables and liquidity, and if so the directions and magnitudes of the effects.
3.5 Model Specification and Variable Description
According to Brooks (2008), it is very easy to generalize the simple model to one with k
Page | 24
regressors (independent variables).Y i=β 0 + β 1 x 1 + β 2 x 2 +… β i x i +ε i , i=(1 ,2 …i )
Where Yi is the ith observation of the dependent variable, x 1,…, x i are the ith observation of
the independent variables, β0,…,βi are the regression coefficients, εi is the ith observation of
the stochastic error term.
To examine the theory underlying the field, we statistically tested the relationships between
Liquidity, Capital adequacy, inflation rate, loan growth, and number of branches, number of
ATM, economic growth, inflation and Interest rate by using multiple regression models. The
regression equation is comprised of the various variables:-
Coming back to the model, based on the general model provided earlier and on the base of
Selected variables the empirical model used in the study was as follows:
Y t =β 0 + β i x t + ε t … … … … … … … (1)
Put in regression form as liquidity function of equation (1) becomes:
LIQt =β 0 + β 1 ❑t + β 2 cap t + β 3 npl t + β 4 nobt + β5 noat + β 6 lg t + β 7 r t + β 8 infl t + β 9 gdp t +ε t (2)Where,
the parameters β1, β2, β3, β4, β5, β6, β7, β8 and 𝛽9 are the long run elasticity’s of the independent
variables and 𝛽0 is the value of the dependent variable when all independent variables are
zero; and LIQt is liquidity of a bank on year, ❑t is the profitability for bank at time t, cap t is
capital adequacy for bank at time t, npl t is the non-performing loans for bank at time t, nob t is
number of branches at time t, noat is the number of ATM at time t, lg t is the loan growth for a
bank at time t, gdpt is the real domestic product/GDP growth of Ethiopia on the year, r t is
interest rate margin on the year t,infl t is the overall inflation rate in Ethiopia on the year t and
ε tis error term used for predicting the value of Y.
3.5.1 Independent Variables

This study is focused to measure factors of liquidity of Bank of Abyssinia S.C in Ethiopia. As
it was discussed in the literature review part, some factors which have positive relation with
liquidity in one country may have negative relation with other country and some factors
which have significant impact on liquidity in one country may not have significant impact on
liquidity in another country. Though various bank specific and macroeconomic variables were
conducted in the previous studies made worldwide, in this study some new variables are
included in bank specific, industry specific and macroeconomics factors. The study also
considered which factors could influence the liquidity of banks in the Ethiopia, Bank of
Abyssinia S.C. Therefore, the following variables were selected based on Ethiopian context
and previous relevant studies. The description and measurement of variables and their
expected sign is reflected in the table.
Table 3.1 Description of the variables, measurement and their expected relationship
Variables Notation Expected Measurement of Variables
sign
Page | 25
Capital adequacy (CAP) + the ratio of total capital and reserve of the
bank to total asset of the bank
Profitability (Π) - Annual gross profit
Non-Performing Loan (NPL) - Share of non-performing loans from the
volume of total loans on the year
Number of branches (NOB) +/- Number of branches on each year
Number of ATM (NOA) +/- No. of electronic banking outlets
Loan Growth (LG) - Annual loan growth
Interest rate (R) - Interest rate of the year
Inflation INFL) - the rate at which the general price level of
goods and services rises on the year
Economic Growth (GDP) + the annual real growth rate of gross
domestic product
3.5.2 Dependent Variable

Liquidity of a bank is measured by the ratio of total liquid assets to total assets as the indicator
for bank liquidity. (Vodova, 2012), defines liquidity as “the ability of bank to fund increases
in assets and meet obligations as they come due, without incurring unacceptable losses”.
Liquidity can also be defined as a measure of the relative amount of asset in cash or which
can be quickly converted into cash without any loss in value available to meet short term
liabilities. As it was discussed in the literature, there are two methods of measuring liquidity
of banks which are liquidity ratios (stock approach) and liquidity gap (flow approach). The
liquidity gap is the difference between assets and liabilities whereas liquidity ratios are
various balance sheet items ratios which identify liquidity trends.
The liquidity measure provides suggestions about the level of liquidity on which the
commercial banks are operating. Most academic literatures prefer liquidity ratio because this
method is more standardized method than flow approach. This study is intended to use
liquidity ratio approach due to the availability of data. This ratio is used in different
researchers like (Anamika Singhn, Anil Kumar Sharma, 2015, 2016), (Mekibeb, 2016) and
(Vodova, 2011).
Liquidity = Total Liquid asset/ Total Asset
According to NBE establishment proclamation (No. 591) liquidity asset of banks includes
cash on hand, deposit in other bank, and short term government securities that are acceptable
by NBE as collateral (for instance Treasury bill).
3.6 Diagnostic tests

Validity test were conducted to check whether there is any violation of basic assumptions of
Classical Linear Regression Model (CLRM. These tests include normality, stationary, model
adequacy, serial autocorrelation, multicollinearity, and heteroscedasticity tests
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Heteroscadasticity Test - One of the basic assumptions of the classical linear regression
model is the variance of each disturbance term u t, is some constant number equal to δ 2. This
assumption is known as homoscedasticity. If this condition is not fulfilled or if the variance of
the error terms varies as sample size changes or as the value of explanatory variables changes,
then this leads to heteroscedasticity problem. The study employs the ‟ Breusch-pagan” test. If
the pro> ch 2 is greater than 0.05 we cannot reject null hypothesis of constant variance and
hence no heteroscedasticity problem.
Normality Test - The disturbance term Ui is assume to have a normal distribution with zero
mean and a constant variance. The test of residual normality is very important after estimation
in empirical studies. Jarque-Bera (JB) test, skewness and kurtosis test is an important residual
normality test in this study. It is a joint asymptotic test and the test statistics is calculated from
the skewness and kurtosis of the residuals. If the probability of skewness and kurtosis is
greater than 0.05 then the residual follow normally distributed.
Multicollinearity test - it is zero conditional mean assumption that the error term in any
given period is uncorrelated with the explanatory variable in all time periods. ɛ(u t/x) =0 ,t=1, 2,
……..n, where x is explanatory variable in the model. This assumption is used to avoid
multicollinearity problem in the model.
Autocorrelation Test - autocorrelation (serial correlation) arises when the error terms from
different time periods are correlated. Breusch-Godfrey Langrange Multiplier (LM) test is used
in this study to test the presence of serial correlation in the residuals. If the prob > ch 2 is
greater than 0.05 in LM test or the durbin-watson statistics; we accept null hypothesis which
is no serial correlation between the error term in different period of time.
3.7 Estimation Strategies
3.7.1 Stationary test
When working with time series data, it is essential to examine the statistical aspects of the
variables. Regression involving non-stationary (no clear tendency to return to a constant value
or linear trend) often lead to the problem of spurious regression. Stationary Regression is
determined by looking at the t value and critical values. If the t value or t-statistic is more than
the critical values the series is stationary, conversely, if the t-statistic is less than the critical
values, the series is non-stationary. The stationary of the data collected has been tested using
the augmented dickey fuller (ADF) and Phillip-PPerron (PP) test.
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3.7.2 Co-integration Analysis
To test whether there is a long run relationship among all variables; ARDL bound tests for co-
integration is carried out as proposed by pesaran, shin and smith (2001. This model has a
significant advantage such as simple to implement and interpret. The decision is depend on F-
statistics. The long term co-integration test and error correction model is stated below.
n n n n n n
∆ LIQ t=β 0 + ∑ ¿ 1 β 1 Δ ❑t−i + ∑ ¿ 1 β2 ∆ cap t −i + ∑ ¿ 1 β 3 ∆ nobt −i + ∑ ¿1 β 4 ∆ noa t−i + ∑ ¿ 1 β5 ∆ npl t −i+ ∑ ¿
i i i i i i
Based on the ARDL model co-integration result, the long run and short run relationship
between variables were estimated.
CHAPTER FOUR
RESULT AND DISCUSSION
4.1. Introduction
This chapter goes further to analyse the variables from two perspectives. The first perspective
is the angle of series statistics which is univariate angle of analysis, and the second one is
group statistics.
The univariate aspect of this analysis has shown description of each variable beginning from
trend analysis and time discussion. Other forms of univariate analysis include descriptive
statistics and correlation. At multivariate level, co-integration test and regression estimation.
Accordingly, the following tests were carried out. These are checking whether the variables
are stationary or not. Some of the time series data by their nature are not stationary at level, so
the first work is transforming the variables to stationary via differencing. The next step is
testing whether the variables are co-integrated in the long run. The long run relationship
among variables included in the model is proved by applying co-integrations mechanism if
the variables are integrating of the same order or I (1) and the researcher utilized vector error
correction model (VECM) to run the short run and the long run models
4.2. Descriptive Statistics

This section presents the descriptive statistics of dependent and explanatory variables used in
this study. The dependent variable used in this study was liquidity (response variable):
explanatory variables are Gross Domestic Product(GDP), Inflation(infl), interest rate(r),
profit(), (Non- Performing Loan (npl), Capital Adequacy (cap), loan growth(lg), No.of
branches & No. of ATM.
Table 4.1: Summary of descriptive statistics of study variables over the period of 1998-2023
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stats liq gdp infl r  npl cap lg nob noa
Mean 0.1820 0.3150 0.1408 0.0708 0.0786 0.1158 0.1421 0.2460 175.61 170.61
Max 0.3305 1.5581 0.364 0.74 0.523 0.5338 0.2037 0.7657 849 1277
Min 0.10903 -0.021 -0.106 0.065 0.001 0.0112 0.1017 -0.0384 4 0
Sd 0.06975 0.44248 0.11387 0.00274 0.13514 0.1316 0.02778 0.20186 242.819 353.31
Skewness 0.82277 1.55207 0.31304 -0.7392 2.48668 1.6238 0.74712 1.29450 1.62943 2.1597
kurtosis 2.65300 3.97336 2.75976 3.18261 7.91138 5.2465 2.66050 4.34627 4.46563 6.2386
Source: stata computation
If the value of the variable in its skewness has positive, negative and zero, it has right tail, left
tail & normally distributed respectively. If the value of the kurtosis has three also called
mesokurtic, greater than three (leptokurtic) and less than three (platykurtic)
The serious has normally distributed, positive kurtosis and negative kurtosis respectively.
Accordingly, all the variable except interest rate have positive value in its skewness, then it
has right tail. The variables liquidity, inflation and capital adequacy are platykurtic i.e. less
than three whereas the rest of variables are positive kurtosis, their serious is peaked curve
relative to normally distribute.
As shown in the table 4.1 above, bank liquidity is proxy by total liquid asset to total asset. The
mean value of bank liquidity was around 18.2 percent of the total asset for Bank of Abyssinia.
It can be noticed that the bank liquidity fluctuates between 10.90 to 33.05 percent.
Natacha Valla (2006) studied the dynamics of liquidity flows within the French banking
system between 1993 and 2005. As result, the researcher concluded that about 8% of the
aggregate liquidity in the banking systems is reshuffled among individual banks on each
quarter. The Dimension of liquidity fluctuations within the banking system (expansions,
contractions and overall reallocation) on the basis of individual bank data.
Number of branches was minimum 4 and maximum 849 in number with standard deviation of
242 and a mean of 175. Non-performing loan was minimum 0.2 and maximum 11.35 in
number with standard deviation of 3.57 and a mean of 4.11. Number of ATM was minimum 0
and maximum 1277 in number with standard deviation of 353 and a mean of 170. Loan
growth ranges from -3.8 percent to 76.5 percent. It has a mean of 246.05 percent with 169.55
percent variation. Capital Adequacy ratio is measured using total capital and reserve divided
by total assets and its value ranges from a minimum of 10.1 percent to maximum of 20.3
percent with a mean value and standard deviation of 14.21 percent and 2.77 percent
Page | 29
respectively. It can be noticed that the bank profit fluctuates between 52.37 percent and 1.0
percent.
The descriptive analysis obtained from the study variables over the study period are shown by
Table 4.1 Interest Rates spread had a minimum of 6.5 percent, maximum of 7.4 percent,
standard deviation of 2.7 percent and a mean of 70.8 percent. The inflation or average price of
goods and service on the basis of inflation in the country over the sample period was recorded
an average of 0.14 unit. The rate of inflation was highly dispersed which exhibits higher
dispersion larger than its mean value over the periods under study towards its mean with
standard deviation of 0.11unit. This clearly shows that there was a bit more variations in terms
of cost of living as it measured by inflation consumer price index.
The other external factor is economic growth showed the mean GDP in Ethiopia from the year
1998 up to 2023 is 0.31 unit with a maximum of 0.15 unit and a minimum of -0.21 unit and
the standard deviation was 0.44 unit during the period of 1998 to 2023 (incorporating 2023).
4.3. Trend Analysis
This Trend analysis involves analysing statistical data to gain a valuable insights into the
direction or tendencies of liquidity and its explanatory variable over a period . Looking at the
trend of the variables would enable the readers to understand how the variables changed over
time. Trend analysis is a graphical illustration of the variables in the model for a given period
of time. It depicts the ups and downs (fluctuations) of the variables due to several factors from
the time 1998 to 2023.
Figure 4.1: Liquidity
.35
.3
liquidity
.25
.2
.15
.1
2000 2005 2010 2015 2020 2025

years
liquidity liquidity
Source: Bank of Abyssinia Annual Report and NBE annual report

A 26 year data on liquidity of Bank of Abyssinia shows that there has been a non-stable trend
over the years. The trend shows an upward movement of liquidity from 1998 to 1999 and
Page | 30
2000 till 2004 signifying the volume of funds circulating within the Bank. From the above
figure 4.1 we can conclude that liquidity increase from 1998 to 1999, 2000 to 2004 but it
decrease on the year 2000 & 2005 etc. i.e. some of the time increase and decrease. This
condition shows the relative amount of asset in cash is not the same over the period.
Figure 4.2: Profitability
figure 4.2 : profitability

.5
.4
profit
.3
.2
.1
0
2000 2005 2010 2015 2020 2025

years
Source: - Bank of Abyssinia Annual Report and NBE annual report
The profit of Bank of Abyssinia from 1998 to 2023 is represented in the diagram above. From
the above figure we can conclude that the steady growth in profit is evidenced from 1998-
2020 where a slight drop is witnessed. However from 2021 to 2023 is increase with at
increase rate.
Liquidity focuses on cash, assets, and short-term liabilities. Profitability focuses on profits in
relation to revenue, assets, equity, and other inputs. In this literature, higher liquidity suggests
greater short-term financial health. The high levels of liquidity maintain equilibrium between
the motive for profit and the satisfaction of financial obligations of customers.
Figure 4.3: Loan Growth
Page | 31
figure 4.3: Loan Growth
.8
loan growth
.6
.4
.2
0
2000 2005 2010 2015 2020 2025

years
Source: - Bank of Abyssinia and NBE annual report
The above graph shows the trend line of loan growth in Bank of Abyssinia. It reflecting the
amount of funds advanced to financial units and economic agent in Ethiopia within the period
of 1998 to 2023. Similarity with other variables, it has a rising & falling trend which can be
attributed to profit and to the expansion of the financial sector in Ethiopia. It peaked in 2017
& 2021 with 76.06 & 76.57 million worth of additional loans disbursed for various sectors
respectively. From the above figure we can conclude that loan growth from 1998 to 2023 is
unstable. I.e. one time decrease & increase on some other time, this condition shows the loan
growth is vary through time.
4.4. Unit Root Test

The way of determining stationary of the variables is called ‘unit root test’. The most widely
applied methods of testing stationary are Augmented Dickey Fuller (ADF) and Phillips
PPerron
The mean and the variance of the stationary variable do not change over time and hence the
mean and variance are time independent. However, stationary problem is unlikely exist for
most macro variables despite it is a key requirement for the validity of time series regression.
If the variables are not stationary in level, it is required to transform the variable towards
stationary process through differencing before proceed to the next step. The Augmented
Dickey-Fuller and PP unit root tests excluding intercept & trend would have applied to
determine the order of integration of the variable.
The acceptance of the level of stationary is based on, either comparing t statistic against
critical values or significance of p-value of the respective variable. If the test statistic is less
than the test critical values or if the p-values are greater than conventional significance levels
(1 percent and 5 percent), all included variables are non-stationary in their levels. There is a
need for these variables to difference to make them stationary.
According to (Pesaran et al., 2001), the ARDL approach requires stationary of the variables
under consideration either at level or at first difference form (integrated of order one) i.e. (I
Page | 32
(0) or I (1). Testing for unit root was a matter of concern and helpful to avoid non-sense
regression (spurious regression). Hence, it is necessary to apply tests such as the Augmented
Dickey Fuller (ADF) and Phillips Perron test.
4.4.1. Augmented Dickey Fuller (ADF) test
In time series data to estimate appropriately variable must be stationary. The most common
known method to estimate the unit root is the Augmented Dickey Fuller (ADF) test.
The results of ADF from table 4.2 below shows that the variables under consideration exhibits
both I (0) & I (1). The variables noa is stationary at level I (0), whereas gdp, Π, lg, infl, r, npl
and CA are stationary at difference I (1). The unit root test result of ADF is tabulated below:
Table 4.2: Augmented Dickey-Fuller Unit Root Test results
ADF-test
Variables At level First-Difference

Critical value Critical value at Conclusion
t-statistics at 5% t-statistics 5% significance
significance level
level
gdp 1.877 -1.950 -2.280 -1.950 I(1)
infl -0.611 -1.950 -6.090 -1.950 I(1)
r 1.415 -1.950 -3.240 -1.950 I(1)
Π 1.090 -1.950 -2.105 -1.950 I(1)
npl 0.146 -1.950 -2.724 -1.950 I(1)
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cap 0.159 -1.950 -3.907 -1.950 I(1)
lg -1.592 -1.950 -4.892 -1.950 I(1)
noa 3.658 -1.950 1.076 -1.950 I(0)
Source: Authors’ calculations using stata computation
4.4.2. Phillips -Perron (PP) tests
The (Phillips, P. C., & Perron, P., 1988) (PP) test model used to test for the presence of a unit
root and which is an alternative testing method for ADF test. The following table 4.3 i.e. the
(Phillips, P. C., & Perron, P., 1988) (PP) test would test the unit root as follow.
Table 4.3: Phillips –Perron Unit Root Test results
Phillips Perron (PP) test
At level(I(0)) First-Difference(I(1))
Critical value at Critical value at
5% significance 5% significance
Variables t-statistics t-statistics Conclusion
level level
gdp 2.476 -1.950 -3.075 -1.950 I(0,1)
infl -1.010 -1.950 -6.628 -1.950 I(1)
r 1.454 -1.950 -4.796 -1.950 I(1)
Π 4.014 -1.950 -2.221 -1.950 I(0,1)
npl 0.163 -1.950 -3.978 -1.950 I(1)
cap 0.445 -1.950 -10.584 -1.950 I(1)
lg -2.399 -1.950 -7.866 -1.950 I(0,1)
noa 4.355 -1.950 -1.273 -1.950 I(0)
Source: Authors’ calculations using stata computation

Even though, Augmented Dickey Fuller (ADF) test is more reliable than PP test, the PP test is
proposed for the large volume of financial data and that corrects the statistics to consider the
autocorrelation and heteroscedasticity issues.
Page | 34
The results of ADF and PP unit root tests in table 4.2 & 4.3 respectively indicated that, some
of the variables are non-stationary at level meaning that, there is a unit root problem in order
of I (0).But those time series variables are stationary at first differenced or the variables are
co-integrated of same order (1) at 5% level of significance. Thus, the variables are free from
the issue of unit root that is showing, the existing of long run relationship among the
variables.
4.5. Diagnostic Tests

Before applying the model estimates for economic analysis, the results were subjected to
several econometric tests.
Diagnostic tests were performed to check for the validity of the parameters. There are
different types of diagnostic tests. But based on the modelling techniques the most common
used Diagnostic tests in many empirical studies are coefficient diagnostics, residual
diagnostics and lag structure. From these different Diagnostic tests, residual diagnostics is the
most desirable in econometric modelling. The most popular methods of testing the residual
diagnostics tests such as multicollinearity test, normality test, serial correlation LM test, and
hetroscedasticity test discussed below.
4.5.1. Test of multicollinearity
The term multicollinearity refers to the existence of a “perfect,” or exact, linear relationship
among some or all explanatory variables of a regression model .One way to detect
multicollinearity is using metric known as the variance inflation factor (VIF) and pair wise
correlation between variables, which measures the correlation between the independent
variable in the regression model. Correlation is a way to index the degree to which two or
more variables are associated with or related to each other. The correlation matrix in table 4.4
predicts the likely relationship among variables in the study.
Table 4.4: Correlation Matrix
gdp infl r Π npl cap lg noa
gdp| 1.0000
infl| 0.2059 1.0000

1.0000
r| 0.6221 0.5242 1.0000
0.0249 0.1547
Π| 0.4671 0.5276 0.7356 1.0000
Page | 35
0.4084 0.1456 0.0005
npl| 0.1882 0.2366 0.3364 0.6460 1.0000
1.0000 0.9996 0.9347 0.0102
cap| 0.1590 0.0472 0.4476 0.4331 0.1201 1.0000
1.0000 1.0000 0.4614 0.5366 1.0000
lg| -0.0720 -0.0255 0.1609 0.1000 -0.1568 0.3136 1.0000
1.0000 1.0000 1.0000 1.0000 1.0000 0.9709
noa| 0.1860 0.4105 0.7320 0.6560 0.4910 0.4222 0.3637 1.0000
1.0000 0.6952 0.0009 0.0103 0.3008 0.6366 0.8834
According to Lewis-Beck (1993) suggestion in order to find out the multicollinearity problem,
the bivariate correlations among the independent variables should be examined and the
existence of correlation about 0.80 or larger indicates a problem of multicollinearity. Hair et
al (2006) argued that correlation coefficient below 0.9 may not cause serious multicollinearity
problem. I.e. if pair- wise or zero-order correlation coefficient between two regressors is out
of the recommended range of multicollinearity which is -0.9 or 0.9. From the table 4.4
correlation matrix, there is no pair-wise relation that exceeds 0.9 which suggests for rejecting
the null hypothesis (H0). In this regard, it can be concluded that all independent variables are
not excessively correlated with each other or the problem of multicollinearity doesn’t exist
between variables in the model. Besides this, it is essential for cross checking the existence of
multicollinearity via Variance Inflation Factors (VIF)
Table 4.5: Variance Inflation Factors

Variable VIF 1/VIF
r 6.34 0.157621
Π 4.63 0.216208
noa 4.37 0.228795
npl 2.71 0.368433
gdp 2.48 0.403566
infl 1.82 0.549356
cap 1.67 0.597390
lg 1.50 0.666935
Mean VIF 13.52
Since VIF of all variables are less than 10 then there is no multicollinearity or free from
multicollinearity.
Test of Normality
Skewness Kurtosis test for normality: Skewness is a measure of the asymmetry of the
probability distribution of a random variable about its mean. It represents the amount and
direction of skew. On the other hand, Kurtosis represents the height and sharpness of the
Page | 36
central peak relative to that of a standard bell curve. The figure below shows the results
obtained after performing the Skewness and Kurtosis test for normality in STATA.
Table 4.6: Normality test Result
Jarque-Bera test
Equation chi2 df Prob > chi2
liq 0.324 2 0.85058
ALL 0.324 2 0.85058
Skewness test
Equation Skewnes chi2 df Prob>
s chi2
liq .25207 0.254 1 0.61417
ALL 0.2541 1 0.61417
Kurtosis test
Equation kurtosis chi2 d Prob>
f chi2
liq 2.7363 0.070 1 0.79202
ALL 0.0701 1 0.79202
Skewness test shows the probability of skewness is 0.614 implying that skewness is
normally distributed (p-value of skewness > 0.05). Similarly, (Kurtosis) its p-value is
0.792 indicates that kurtosis is also asymptotically distributed (p-value of kurtosis >
0.05). Therefore, it is typically believed that the data are normally distributed because the
p-value is higher than the significance level . Consequently, the null hypothesis cannot be
rejected. Therefore, according to the Skewness test or kurtosis test or both, residuals show
normal distribution.
4.5.2. Test of heteroskedasticity

To test for the presence of heteroscedasticity, Breusch-Pagan test was employed. This test
involves testing the null hypothesis that the variance of the errors is constant
(homoscedacticity) or no heteroscedasticity versus the alternative that the errors do not have a
constant variance.
Table 4.7: Heteroskedasticity Test:
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity
Ho: Constant variance
Variables: fitted values of liq
chi2(1) = 0.65
Prob > chi2 = 0.4185
Breusch-Pagan-Godfrey heteroskedasticity test result in Table 4.7 shows that the probability
value (0.4185) is greater than 0.05 level of significance. Thus, we fail to reject the null
Page | 37
hypothesis stating the dependent variable has a constant variance. This implies that relevant
variables are not omitted. Therefore, the functional form of the model is correct. After all, we
don't reject the null hypothesis and conclude that there is no hetroskedasticity problem.
4.5.3. Serial Correlation

Serial correlation is a time series problem. It happens when error terms correlate with each
other at different times. The study used Breusch-Godfrey test to check whether errors term
correlated or not (Gujarati, 2003).
Table 4.8: Breusch-Godfrey Serial Correlation LM Test result
Breusch-Godfrey LM test for autocorrelation
lags(p chi2 df Prob > chi2
1 0.015 1 0.9041
H0: no serial correlation
From the above table since, p-value (0.9041) is greater than 0.05 or 5% levels of significance
which imply that the null hypothesis of no serial correlation cannot be rejected. Thus, this
necessitates the acceptance of null hypothesis and therefore concludes that the model has no
serial correlation problem. Diagnostics test are summarized below
Diagnosis Type of Test Null hypothesis Prob. Conclusion
Applied
Autocorrelation Breusch-Pagan- No serial correlation 0.9041 Do not reject
Godfrey HO
Heteroscedasticity Breusch-Pagan- No Heteroscedasticity 0.4185 Do not reject
Godfrey HO
Normality Jaque- Bera No normality 0.85058 Do not reject
HO
Table 4.9 Summary of Diagnostic test
4.6. Optimal lag length selection

Before estimating the VECM model, determining the number of lags is very important in
econometrics studies because the larger the lag interval shows the dynamic nature of the
model. But in this case, more parameters will be needed to be estimated to constantly reduce
model degree of freedom. There are different methods of lag selection criteria, but the most
popular method is Akaike's information criterion (AIC).
As shown from table 4.9 below the optimal lag length for all likelihood ratio, akaike
information criterion, hanna-quin information criterion and schawarz and Bayesian
information criterion are three. According to Akaike information criterion (AIC), there are
four number of lag length, and it is the optimal lag order obtained from the result of lag length
criteria at five percent level of significant. It is good to apply minimizing an information
Page | 38
criterion to choose optimal lag because it provides a consistent estimator of the number of co-
integrating equations (Aznar & Salvador, 2002; Gonzalo & Pitarakis, 1998).
Since the researcher have used time series data, many researchers advised to use lower lag
that is between one or two optimal lags but the author in this paper use four lags because there
are twenty-six observations and also the information criterion automatically selects the
optimal length.
Table 4.10: lag selection results for VAR with ten variables
Endogenous: liq gdp infl r Π npl cap lg nob noa
lag LL FPE AIC HQIC SBIC
0 29.0978 8.3e-14 -1.73617 -1.61934 -1.24024
1 332.261 2.1e-21 -20.2055 -18.9204 -14.7503
2 NA -3.e-157* NA NA NA
3 7046.27 NA -620.57* -618* -609.659*
4 7011.86 NA -617.442 -614.872 -606.531
N.B * indicates the lowest value under each criteria
STATA in this command computes four information criteria. In literature, many studies used
the AIC, HQIC or both. Lower the value better the model as seen in table 4.9 which is -
620.57*. Here the researcher choose lag three according to AIC -620.57* with the minimum
value. In the model, three criteria s AIC, HQIC & SBIC Suggested lag three. Finally, the
researcher use this lag length using VAR, VECM diagnostics tests.
4.7. The ARDL Bounds testing result
ARDL bounds testing is the co-integration method developed by pesaran et al. (2001) to test
presence of the long run relationship between variables.
Hence, as it can be seen from table 4.3 and 4.4 above, the variables have exhibited I (0) and I
(1), so it is possible to use them for the ARDL model. The main assumption of ARDL is that
the variables in model are co-integrated to the order of I (0) or I (1) or both, and the next step
will be examination of existence of long run relationship among dependent and independent
variables has been tested by applying the ARDL bound test. The lag length that maximum is 4
and accordingly the calculated F-statistic (F-statistic = 7.391) which is higher than the upper
bound critical value at 2.5% level of significance (4.18) on the stata. Furthermore, the F value
is higher than (3.586 & 4.15) both at 10% significance level using no trend and intercept as
well as restricted intercept and trend as reported by Pesaran et al. (2001).
This is done, firstly by estimating the long run equation of the model by using the ARDL
estimation method with a maximum of 4 lags for both the dependent and independent
variable.
Page | 39
Table 4.11: Bound test result
Pesaran/Shin/Smith (2001) ARDL Bounds Test
F = 7.391
t = -6.213
H0: no long run relationship exist
Test Statistic Value k
F-Statistic 7.391 6
Critical value Bounds
Significance level Lower Bound,I(0) Upper Bound,I(1)
10% 2.12 3.23
5% 2.45 3.65
2.5% 2.75 3.99
1% 3.15 4.43
Source: Author’s calculation using stata computation
(i) accept if F < critical value for I(0) regressors (ii) reject if F > critical value for I(1) regressors
Result from Table 4.11 shows, the value of the F-statistic (i.e. 7.391) is greater than critical
values presented by pesaran et al. (2001) suggesting long run relationship among included
variables.
The decision rule for the bound test is to reject the null hypothesis of no long run relationship
exist. If the F statistic is larger than the upper bound at 5% significance level, reject null
hypothesis. If the F statistic is lower than the lower bound at 5% significance level, accept the
null hypotheses. Inconclusive about the existence of long run relationship if the F statistic lies
between the lower and upper bounds.
As we can see from table 4.11 above the F statistic (7.791) is larger than the upper bound
even at 1% significance level so we reject the null and we accept the alternative hypotheses of
long run relationship. In short there is long run relationship in the model.
4.8. ARDL model in error correction model

ARDL is a general model that can analyze both short-run and long-run relationships. An error
correction model (ECM) belongs to a category of multiple time series models most commonly
used for data where the underlying variables have a long-run common stochastic trend, also
known as co-integration. Then running the appropriate ARDL model to find out the long run
coefficients, as reported in table 4.13 below. Estimated long run coefficients using the ARDL
(2, 2, 1, 2, 2, 1,2) regression selected based on Akaike information criterion as follow.
Page | 40
4.8.1. Short run in error correction Model
The next step after the acceptance of long run coefficients of the liquidity equation is
estimation of the short -run ECM model. The coefficient of the error correction term indicates
how quickly variables converge to equilibrium. Moreover, it should have a negative sign and
statistically significance at a standard significance level (i.e. P - value should be less than
0.05). The Short Run Error Correction Representation for the Selected ARDL (2, 2, 1, 2, 2, 1,
2) ec selected based Akaike Information Criterion as the below table.
Table 4.12: Short Run estimation result
Variables Coef. Std. Err. t-Statistic Pro, P>|t|
LD.liq .176423 .1712242 1.03 0.350
gdp. .7393284 .1817235 4.07 0.010
infl .192408 .0605696 3.18 0.025
Π 1.555427 .365502 4.26 0.008
npl -.3732848 .1658498 -2.25 0.074
lg .1362993 .0476857 2.86 0.035
r -17.92444 5.045808 -3.55 0.016
ECT(-1) -1.687267 .3371026 -5.01 0.004
R-squared (R2) = 0.9730 and Adj R-squared = 0.8757 N= 24
Source: stata Computation
The table 4.12 above regression result demonstrates that a number of variables impact on
liquidity over the short term. A long-term relationship between liquidity and the modelled
explanatory variables is confirmed by the coefficient of error correction model (ECM (-1)),
which was revealed negative and significant even at the 1% level of critical value based on
the ARDL Model results shown in table 4.12 above. Liquidity is implied to moderately adjust
to its long run path over the course of a year by the negative and considerable coefficient of
the error correction model.
Accordingly, the error correction coefficient estimated at -1.68 is significant at 1%

significance level and has the recommended negative sign. According to Gebrehiwot (2016),
the highly significant error correction term further confirms the existence of a stable long-run
relationship.
Moreover, the coefficient of the error term (ECM-1) implies that the deviation from long run
equilibrium level of liquidity in the current period is corrected by 168.72 %, in the next period
to bring back equilibrium when there is a shock to a steady state relationship.
The negative values in speed of adjustment indicate the impact of shocks on liquidity is
declining over time. Gross domestic product (gdp), Profit (Π), interest rate, loan growth (lg)
and inflation (infl) are the variables that significantly affect liquidity at 5% significant level in
the short run.
Page | 41
Accordingly, a one unit increase in gross domestic product leads to 0.73 increase in liquidity,
a one unit increase in profit leads to a 1.55 increase in liquidity, a one unit increase in interest
rate leads to 17.92 decline in liquidity and a one unit increase in loan growth leads to 0.13 rise
in liquidity with keeping other variables constant.
4.8.2. Long run in error correction model
ARDL long run form bound test is a test of statistics that can be used to test for a long-run
relationship between two or more variables.
Coming back to the model, based on the general model provided and on the base of
Selected variables the long run model used in the study is as follows:
Y t =β 0 + β i x t + ε t … … … … … … … ( 1 )
Put in regression form as liquidity function of equation (1) becomes:
LIQt =β 0 + β i x t + ε t … … … … (2) x t , is the explanatory variables which determine liquidity in the
model then, the model becomes
: LIQt =β 0 + β 1 ❑t + β 2 cap t + β 3 npl t + β 4 nobt + β5 noat + β 6 lg t + β 7 r t + β 8 infl t + β 9 gdp t +ε t … … … … .(3)
Where, the parameters β1, β2, β3, β4, β5, β6, β7, β8 and 𝛽9 are the long run elasticity’s of the
independent variables and 𝛽0 is the value of the dependent variable when all independent variables
are zero. ε is error term used for predicting the value of Y.
LIQt is liquidity of a bank on year, ❑t is the profitability for bank at time t, cap t is capital adequacy
for bank at time t, npl t is the non-performing loans for bank at time t, nob t is number of branches at
time t, noat is the number of ATM at time t, lg t is the loan growth for a bank at time t, gdpt is the real
domestic product/GDP growth of Ethiopia on the year, r t is interest rate margin on the year t, infl t
is the overall inflation rate in Ethiopia on the year t and ε t is error term used for predicting the value
of Y.
Based on the equation above, the long term co-integration test and error correction model is
presented below.
n n n n n n
∆ LIQ t=β 0 + ∑ ¿ 1 β 1 ∆ gdp t−i + ∑ ¿ 1 β8 ∆ infl t −i + ∑ ¿1 β 1 Δ ❑t−i + ∑ ¿ 1 β 5 ∆ npl t−i + ∑ ¿ 1 β6 ∆ lg t −i + ∑ ¿1
i i i i i i
The test depends on the idea that the error correction term will be significant. The variables
has a long-run relationship. ARDL (2, 2, 1, 2, 2, 1, 2) ec
Table 4.13: Long Run estimation result

Variables Coef. Std Err. t-Statistic Prob, P>|t|
Liq.( L1) -1.687267 .3371026 -5.01 0.004
Page | 42
gdp -.2477291 .0462305 -5.36 0.003
infl -.0435151 .0554414 -0.78 0.046
Π -.8177169 .1837645 -4.45 0.007
npl .5647709 .0625344 9.03 0.000
lg -.0966178 .0403253 -2.40 0.006
r 4.495277 1.229412 3.66 0.015
cons .0426213 .0908779 0.47 0.659
Source: Stata computation
Table 4.13 lists the explanatory variables' long-run coefficients, standard errors, t-statistics,
and probabilities. On the basis of the Akaike information criterion (AIC), the model's ideal
latency was chosen.
This section discusses in detail the analysis of the results for each explanatory variable and
their effect on the liquidity of Bank of Abyssinia in Ethiopia. Furthermore, the discussion
analysed the statistical findings of the study in relation to the previous empirical evidences.
The variables are simply tested for co-integration over the long term using the co-integration
method. The findings in table 4.13 above demonstrate that the variables have a long-term
relationship or that co-integration holds true. The table 4.13 above displays the results of the
regression analysis performed on these variables.
When we look the sign of the coefficients of individual variables, npl and r have positive and
they are significant to the model at 5% of level of significance. The sign of the estimated
coefficient lg, gdp, π and infl is negative and statistically significant to the model at 5% level
of significance over the long term during the long study period.
GDP and liquidity
Gross domestic product (GDP) was among the macroeconomic variables that affected
liquidity of Bank of Abyssinia. It is statistically significant at 5% significance level with the
p-value of 0.003. And has a negative coefficient of (i.e. -0.2477) indicated that a unit
increases in annual real GDP rate leads to 24.77 unit decreases in liquidity of Bank of
Abyssinia, holding other variables constant. The finding of this study was in line with the
findings of Vtyurina(2012); Vodová (2011); (Valla et al. 2006); Aspachs et al.(2005).
In line with the above argument the loanable fund theory of interest‟ states that the supply for
loan (i.e. illiquid assets for banks) increases when the economy is at boom or going out of
recession (Pilbeam 2005). Banks hoard liquidity during periods of economic downturn when
lending opportunities may not be as good and they run down liquidity buffers during
economic expansions when lending opportunities may have picked up. Thus, it can be
Page | 43
expected that higher economic growth make banks run down their liquidity buffer and induce
banks to lend more (Aspachs et al. 2005). Hence, the finding of this study showed that when
the economy growth faster and hence investment increases this means financial sector ( i.e.
Bank of Abyssinia) preferring more risky capital assets with higher return and they were more
likely to hold less liquid capital assets and to incur short-term debt with higher interest rates.
The finding is consistent with the studies conducted by Tseganesh (2012), Belete (2015),
Nigist (2015), Rahel (2019). Therefore, reject the expected sign stated; there was negative and
statistically significant relationship between GDP growth rate and banks liquidity.
Profitability and liquidity
The long run estimated result shows that, profitability had negative and statistically significant
impact on liquidity at 5 percent level of significant with p-value 0.007. The coefficient of -
0.8177 showed that a 1% rises in banks liquidity leads to 81.77% decrease in the ratio of
financing gap to total asset, holding other variables constant. This finding was consistent to
the findings of Vtyurine et al. (2012); Vodová (2011); Berger and Bouwman (2007);
Aspaches et al. (2005); Deep and Schaefer (2004). Also Valla et al. (2006) asserts that bank
profitability which is according to finance theory negatively correlated with liquidity. Besides,
it was in line with the arguments of that; holding liquid assets imposes an opportunity cost on
the bank given their low return relative to other assets, which indicated the inverse
relationship between liquidity of bank and profitability (Molyneux and Thornton 1992;
Goddard, et al. 2004). Also the adverse effect of increased liquidity for financial institutions
stated that although more liquid assets increase the ability to raise cash on short-notice, they
also reduce the ability of management to commit credibly to an investment strategy that
protects investors‟ which finally can result in reduction of the firm’s capacity to raise external
finance‟ in some cases (Myers and Rajan 1998). Hence, both the empirical founding’s of the
previous researchers‟ and theoretical argument supported the finding of this study in that
there was negative and statistically significant relationship between profitability and liquidity
of Bank of Abyssinia in Ethiopia. Therefore, fail to reject the hypotheses stated; there was
negative and statistically significant relationship between profitability and banks liquidity.
Loan Growth and liquidity
Annual growth rate of gross loans and advances to customers was used as a proxy for loan
growth and which has a negative coefficient of -0.0966. The result shows that a one unit
increase in loan growth, results in a -0.0966 unit decrease in liquidity, keeping other variables
constant which means that the growth of loan negatively affect the liquidity of Bank of
Page | 44
Abyssinia in Ethiopia. Besides, the negative impact of loan growth on liquidity, its p-value of
0.006 was statistically significant at 5% significance level. According to this argument when
the amount of loans provided by banks increase, the amount of illiquid assets in the total
assets portfolio of banks increase and lead to the reduction in the level of liquid assets held by
banks. Therefore, this finding reveal that larger amount of loans was provided from periodic
deposits with affecting the amount of liquid assets held bank of Abyssinia in Ethiopia.
Therefore, the hypothesis stating negative and significant relationship between loan growth
and banks liquidity should be accepted. The finding was similar to the findings of Tseganesh
(2012) and it is opposite to Belete (2015), Berhanu (2015, Alemayehu (2016) and Rahel
(2019).
Inflation and liquidity
Inflation was the other macroeconomic variables of this study and found to be statistically
significant factor in explaining liquidity of Bank of Abyssinia with the p-value of 0.015.The
% change in CPI has a negative coefficient of (i.e. -0.0435); which means that one percent
increase in %change in CPI leads to 4.35% decreases in liquidity of Bank of Abyssinia,
holding other variables constant.
The negative and statistically significant impact of inflation was in line with expectation of
the study. This negative relation was based on the theory that during inflationary economy,
bank of Abyssinia are not refraining from long term investment and prefer to hold risky liquid
asset. During inflation, it is expected that, banks will make fewer loans and the amount of
liquid or short term assets held by economic agents including banks will fail. The result of this
study is opposite to the findings of Tseganesh (2012), Belete (2015), Alemayehu (2016) and
Rahel (2019). It has a negative effect for the dependent variable liquidity.
Non-Performing loan and liquidity
Non-performing loan of Bank of Abyssinia in this study was measured by the ratio of
provision for impairment loses to the total outstanding loan and advance to customer found to
be significant with the p-value of 0.000 and has a positive coefficient of (i.e. 0.5647)
Page | 45
The coefficient of 0.5647 indicated that for 1% rises in the NPL leads to a 56.47% increase in
liquidity of bank of Abyssinia from specified period under the study, holding other variables
constant(citrous paribus). In the case of the Lithuanian banks, the increase of the impaired
loans ratio had a tremendous impact on their overall liquidity. Banks indicated an increase of
their impaired loans ratio, the Central Bank required higher level of liquidity. Thus the
positive & statistically significant link between the liquidity indicator and the impaired loans
ratio is valid.
Since, the commercial banks in Ethiopia are regulated by the central bank (NBE), they are
very strict in NPL management. Therefore, whenever their NPL is higher they have to offset
with additional loan and advance and in order to avail new loan they have to increase their
liquidity otherwise, increase in amount of non-performing loans (NPL) leads the banking
sector to efficiency problem and the banking system into failure. Therefore, the expected sign
stated; there was negative and statistically significant relationship between non-performing
loan (NPL) and banks liquidity was not accepted.
Interest rate and liquidity
Interest rate margin was the macroeconomic variable of this study and found to be positive
and statistically significant with the p-value of (i.e. 0.015) at 5 percent significance level in
explaining liquidity of Bank of Abyssinia. And the coefficient of 4.4952 indicated that a one
unit increase in r leads to 4.4952 unit increases in liquidity of Bank of Abyssinia, holding
other variables constant. The positive coefficient of Interest rate is in line with the liquidity
preference theory which stated that, lenders need high interest rate which includes the interest
rate margin/ liquidity premium in order to lend besides the positive coefficient of interest rate
margin was quite surprising because it highlighted the fact that higher interest rate margin
didn’t encourage banks to lend more rather it encouraged banks to hold more liquid assets.
Hence, the expected sign stated; there was negative and statistically significant relationship
between interest rate and banks liquidity should be rejected.
As a result, the long run estimate of the ARDL model reveal that these explanatory variables
have a statistically significant beneficial impact on liquidity of Bank of Abyssinia.
CHAPTER FIVE
CONCLUSIONS AND RECOMMENDATIONS
5. Introduction
Page | 46
The completed previous section of this work entailed the empirical findings of the study and
further explained the statistical outcomes of the investigations carried out on the Bank of
Abyssinia Liquidity. It is worthy to note that diagnostic tests have been carried out on the
model and the variables used before regression. This section of the study will delve into the
conclusion of the work and will present the summary of the findings and discussions
presented in the previous chapter.
5.1. Conclusion
The main goal of the research was to determine the factors affecting liquidity in Bank of Abyssinia
over a time. The casual correlations between the variables were explained by an explanatory
research approach. The research utilized quantitative techniques to analyse secondary data obtained
from bank financial statements and NBE publications concerning macroeconomic indicators.The
study so far, has shown based on the length of observation on the Bank of Abyssinia that factors
affecting liquidity. It predicts liquidity based on the explanatory variables effects.
The Autoregressive Distributed Lag shows that the variables inflation, gross domestic
product, profit, non-performing loan, loan growth and interest rate are the factors of liquidity
of Bank of Abyssinia. Besides, those variables has a significant impact on liquidity of Bank of
Abyssinia in the long run as well as short run as a result of ARDL model.
The research questions of this study seeks to know the factors to determine liquidity in Bank
of Abyssinia. In explanation, the phenomenon in play is beyond the regular direct relationship
between the explanatory variables and liquidity. The empirical investigation shows that the
variables gathered in the literature to be the factors of liquidity such as profitability, inflation,
non-performing loan, loan growth, interest rate, gross domestic product, number of branches ,
number of ATM & capital adequacy have evidenced their singular capacities to explain
liquidity in general from the scenario of Bank of Abyssinia within the period.
Secondly, the trend of liquidity fluctuation over a time up on the relative influence of
variables. The Trend analysis shows a valuable insights into the direction or tendencies of
liquidity and its explanatory variable over a period. It depicts the ups and downs (fluctuations)
of the variables due to several factors from the time 1998 to 2023. A 26 year data on liquidity
of Bank of Abyssinia shows that there has been a non-stable trend over the years.
In addition the study applied the methodological approach called ARDL model also known as
bound test approach. As the test result indicated the bound test (F-statistic) value is found to
be larger than the upper bound critical values at five percent significance level, indicating the
Page | 47
existence of a long run relationship between liquidity (liq) and its determinants (profit, gross
domestic product, loan growth, non-performing loan ,interest rate and inflation) during the
study period.
The autoregressive distributive lag analysis done in the previous chapter showed that there is
a negative coefficient of -1.6872 which implies almost 169% inverse relationship between the
explanatory variables and Liquidity. The conclusion of the analysis made so far demonstrated
that co-integration is found among the variables implying that long run association is existent
between the explanatory variables & liquidity. In both short and long run, variables affect
liquidity in Bank of Abyssinia.
In the long run, Gross domestic product (GDP), inflation (infl), profit (π), and loan growth
(lg) have negative and statistically significant impact on the determination of liquidity of
Bank of Abyssinia, however, interest rate (r) and non-performing loan have positive and
statistically significant impact on liquidity of bank of Abyssinia in Ethiopia.
In the short run profit (π), loan growth (lg) ,gross domestic product (gdp) and inflation (infl)
have positive and statistically significant at 5% level of significance that affect liquidity of
Bank Abyssinia, however, non-performing loan is insignificance at 5% level of significance.
While interest rate (r) have negative and statistically significant impact on liquidity of bank of
Abyssinia in Ethiopia.
Thirdly, the research question seeks to understand the external and external factors of
liquidity of Bank of Abyssinia in Ethiopia. It has covered the time period through 1998 to
2023 and the variables under consideration are: Profitability, Capital adequacy, number of
branches, number of ATM, Non-performing loan, loan growth, Interest rate, economic growth
and inflation. Among those variables stated in this literature, profit, non-performing loan and
loan growth are the internal factors whereas gross domestic product, inflation & interest rate
are the external factors of liquidity. Further investigations were conducted by the researcher
and it showed that all variables possess unit roots implying stationary is found among the
variables with co-integration existent in the variables.
The result shows that immediate and short run direct relationship between explanatory
variables (GDP, inflation, profit, and loan growth) and liquidity as well as inverse r/ship on
interest rate but in the long run also proves that liquidity adjusts as shown in ARDL model.
Page | 48
Conclusively, the analysis made so far demonstrated that the time serious analysis explain the
factors of liquidity as the result conform with individual statistical significance of each of the
variables.
5.2. Recommendation
As indicated from the findings and conclusion earlier reached in this study, following
suggestions provided.
 Institutions' tools for implementing liquidity policies need to be examined and

investigated
 The effectiveness and efficiency of measures for managing liquidity, including cash
reserve requirements, open market operations, liquidity ratios, and the monetary policy
rate, must be continuously evaluated by the National Bank of Ethiopia (NBE).
 A strong and solid credit policy should be in place to ensure effective and efficient
credit management by lowering the quantity of non-performing credit that costs banks
nothing.
It is recommended that the Bank of Abyssinia in activity and measures should be conscious
and responsive of the impulses in liquidity reserve levels in order to sustain profitability.
Caution should be taken as other factors such as total assets and total liabilities play their
primary role in liquidity sustenance and should not be neglected because they were not
incorporated on liquidity of Bank of Abyssinia study model as data were not easily
found/readily available.
There are other variables like interest rate on loans, total deposits and efficient management of
liquid assets from internal and government regulation, industry concentration, reserve
requirements and ownership structure from external variables which are not included in this
study. Therefore, further investigation which includes the above variables might have a better
role in identifying other factors contributing to liquidity of Ethiopian banks.
5.3. Suggestions for future studies
Page | 49
The prime focus of this research was on identifying factors affecting liquidity in the case of
Bank of Abyssinia in Ethiopia using selected variables. However, there might be variables
that were not included in this study such as total liability, current assets, market share, and
capital ratio can be incorporated into the model to capture a more robust study. Thus, future
researchers are recommended to undertake similar study by considering additional variables
on the same banks which will be useful to validate findings of the current study. Liquidity and
its determinants can be studied from the angle of other non-financial firms such as companies,
businesses stock exchange market etc.
Page | 50
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Appendix
no
year liq gdp infl r Π npl cap lg b noa
1998 0.11012 0.0782 0.036 0.04 0.001 0.0112 0.122 0.403 4 0
1999 0.21205 0.0701 0.079 0.04 0.006 0.0142 0.1521 0.203 7 0
2000 0.13649 0.0341 0.054 0.04 0.012 0.0153 0.1713 0.1039 10 0
2001 0.21578 0.0741 -0.003 0.04 0.036 0.0262 0.164 0.316 13 0
2002 0.31961 0.0163 -0.106 0.04 0.0049 0.3795 0.1234 -0.0262 13 0
2003 0.32558 -0.021 0.109 0.04 0.0045 0.2843 0.1117 0.2093 17 0
2004 0.33059 0.1173 0.073 0.04 0.024 0.1751 0.1217 0.1891 19 0
2005 0.24419 0.1264 0.061 0.04 0.0297 0.124 0.1234 0.2827 22 0
2006 0.10903 0.1154 0.106 0.04 0.03 0.0494 0.1418 0.5908 25 0
2007 0.17343 0.1179 0.158 0.04 0.0197 0.1054 0.1383 0.1742 28 0
2008 0.14563 0.1119 0.253 0.046 0.0034 0.1287 0.1017 0.2222 45 0
2009 0.25821 0.1004 0.364 0.046 0.0183 0.1475 0.1131 -0.0384 47 0
2010 0.21593 0.1057 0.028 0.046 0.0224 0.0698 0.1156 0.164 48 0
2011 0.21617 0.1129 0.181 0.046 0.0249 0.0397 0.1156 0.0515 59 0
2012 0.19868 0.087 0.341 0.046 0.0263 0.0376 0.1362 0.1754 65 0
2013 0.11912 0.0982 0.135 0.046 0.0269 0.0275 0.1307 0.2065 91 50

Page | 56
10
2014 0.15386 0.1031 0.103 0.05 0.0351 0.0219 0.1752 0.0763 8 62
16
2015 0.21106 0.1041 0.104 0.05 0.0374 0.0131 0.1538 0.1668 6 78
20
2016 0.18443 0.081 0.08 0.05 0.0487 0.0146 0.1476 0.3566 0 86
23
2017 0.13584 0.1091 0.109 0.05 0.0704 0.0129 0.1535 0.7606 3 100
28
2018 0.14044 0.8021 0.138 0.07 0.0765 0.0234 0.1347 0.1778 6 118
33
2019 0.11381 0.9261 0.158 0.07 0.1024 0.0826 0.1902 0.2342 7 174
50
2020 0.11172 0.9661 0.203 0.07 0.1081 0.1677 0.1391 0.3725 3 574
62
2021 0.11621 0.9927 0.269 0.07 0.287 0.2533 0.1983 0.7657 3 892
74
2022 0.12362 1.2037 0.339 0.07 0.465 0.2533 0.1168 0.1133 8 1023
84
2023 0.11159 1.5581 0.291 0.07 0.523 0.5338 0.2037 0.1465 9 1277
Annual ratio data during the year 1998-2023
Page | 57
Descriptiv Statistic
e s
stats liq gdp infl r  npl cap lg nob noa
Mean 0.1820 0.3150 0.1408 0.0708 0.0786 0.115 0.1421 0.2460 175.61 170.61
8
Max 0.3305 1.5581 0.364 0.74 0.523 0.533 0.2037 0.7657 849 1277
8
Min 0.10903 -0.021 -0.106 0.065 0.001 0.011 0.1017 -0.0384 4 0
2
Sd 0.06975 0.44248 0.11387 0.0027 0.13514 0.131 0.02778 0.20186 242.81 353.31
4 6 9
Skewness 0.82277 1.55207 0.31304 - 2.48668 1.623 0.74712 1.29450 1.6294 2.1597
0.7392 8 3
kurtosis 2.65300 3.97336 2.75976 3.1826 7.91138 5.246 2.66050 4.34627 4.4656 6.2386
1 5 3
.35
.3
liquidity
.25
.2
.15
.1
2000 2005 2010 2015 2020 2025

years
liquidity liquidity
ADF-test
Variables At level First-Difference

Critical Critical Conclusion
t-statistics value at 5% t-statistics value at 5%
significance significance
level level
gdp 1.877 -1.950 -2.280 -1.950 I(1)

infl -0.611 -1.950 -6.090 -1.950 I(1)
r 1.415 -1.950 -3.240 -1.950 I(1)
Π 1.090 -1.950 -2.105 -1.950 I(1)
npl 0.146 -1.950 -2.724 -1.950 I(1)
cap 0.159 -1.950 -3.907 -1.950 I(1)
Page | 58
lg -1.592 -1.950 -4.892 -1.950 I(1)
noa 3.658 -1.950 1.076 -1.950 I(0)
Phillips Perron (PP) test
At level(I(0)) First-Difference(I(1))
Critical value Critical value
at 5% at 5%
Variables t-statistics t-statistics Conclusion
significance significance
level level
gdp 2.476 -1.950 -3.075 -1.950 I(0,1)
infl -1.010 -1.950 -6.628 -1.950 I(1)
r 1.454 -1.950 -4.796 -1.950 I(1)
Π 4.014 -1.950 -2.221 -1.950 I(0,1)
npl 0.163 -1.950 -3.978 -1.950 I(1)
cap 0.445 -1.950 -10.584 -1.950 I(1)
lg -2.399 -1.950 -7.866 -1.950 I(0,1)
noa 4.355 -1.950 -1.273 -1.950 I(0)
Correlation Matrix
gdp| 1.0000
infl| 0.2059 1.0000

1.0000
r| 0.6221 0.5242 1.0000
0.0249 0.1547
Π| 0.4671 0.5276 0.7356 1.0000
0.4084 0.1456 0.0005
npl| 0.1882 0.2366 0.3364 0.6460 1.0000
1.0000 0.9996 0.9347 0.0102
cap| 0.1590 0.0472 0.4476 0.4331 0.1201 1.0000
1.0000 1.0000 0.4614 0.5366 1.0000
lg| -0.0720 -0.0255 0.1609 0.1000 -0.1568 0.3136 1.0000
1.0000 1.0000 1.0000 1.0000 1.0000 0.9709
noa| 0.1860 0.4105 0.7320 0.6560 0.4910 0.4222 0.3637 1.0000
1.0000 0.6952 0.0009 0.0103 0.3008 0.6366 0.8834
Page | 59
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity
Ho: Constant variance
Variables: fitted values of liq
chi2 (1) = 0.65
Prob > chi2 = 0.4185
Variable VIF 1/VIF
r 6.34 0.157621
Π 4.63 0.216208
noa 4.37 0.228795
npl 2.71 0.368433
gdp 2.48 0.403566
infl 1.82 0.549356
cap 1.67 0.597390
lg 1.50 0.666935
Jarque-Bera test
Equation chi2 df Prob > chi2
liq 0.324 2 0.85058
ALL 0.324 2 0.85058
Skewness test
Equation Skewness chi2 df Prob>
chi2
liq .25207 0.254 1 0.61417
ALL 0.2541 1 0.61417
Kurtosis test
Equation kurtosis chi2 df Prob>
chi2
liq 2.7363 0.070 1 0.79202
ALL 0.0701 1 0.79202
Breusch-Godfrey LM test for autocorrelation

lags(p chi2 df Prob > chi2
1 0.015 1 0.9041
Lag length selection
lag LL FPE AIC HQIC SBIC
0 29.0978 8.3e-14 -1.73617 -1.61934 -1.24024
1 332.261 2.1e-21 -20.2055 -18.9204 -14.7503
2 NA -3.e-157* NA NA NA
3 7046.27 NA -620.57* -618* -609.659*
4 7011.86 NA -617.442 -614.872 -606.531
Pesaran/Shin/Smith (2001) ARDL Bounds Test
F = 7.391
t = -6.213
H0: no long run relationship exist
Page | 60
Test Statistic Value k
F-Statistic 7.391 6
Critical value Bounds
Significance level Lower Bound,I(0) Upper
Bound,I(1)
10% 2.12 3.23
5% 2.45 3.65
2.5% 2.75 3.99
1% 3.15 4.43
Short Run estimation result

Variables Coef. Std. Err. t- Pro,
Statistic P>|t|
LD.liq .176423 .1712242 1.03 0.350
gdp. .7393284 .1817235 4.07 0.010
infl .192408 .0605696 3.18 0.025
Π 1.555427 .365502 4.26 0.008
npl -.3732848 .1658498 -2.25 0.074
lg .1362993 .0476857 2.86 0.035
r -17.92444 5.045808 -3.55 0.016
Long Run estimation result
Variables Coef. Std t- Prob,
Err. Statistic P>|t|
Liq.( L1) -1.687267 .3371026 -5.01 0.004
gdp -.2477291 .0462305 -5.36 0.003
infl -.0435151 .0554414 -0.78 0.046
Π -.8177169 .1837645 -4.45 0.007
npl .5647709 .0625344 9.03 0.000
lg -.0966178 .0403253 -2.40 0.006
r 4.495277 1.229412 3.66 0.015
Page | 61

Final Revised Thesis - Desale

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ETHIOPIAN CIVIL SERVICE UNIVERSITY

College of Finance, Development and Management

Department of Development Economics

Factors Affecting Banks’s Liquidity in Ethiopia: The Case of Bank of

Desale Fentie Tikuye

Master’s Thesis submitted to the Department of Development Economics in

College of Finance, Development and Management

Department of Development Economics

Factors Affecting Banks’s Liquidity in Ethiopia: The Case of Bank of

Desale Fentie Tikuye

Master’s Thesis submitted to the Department of Development Economics in

Advisor: - Mezid Nasir (PhD)

Addis Ababa, Ethiopia

© 2024 Desale Fentie

College of Finance, Development and Management

Department of Development Economics

Approval of Thesis for Defense

_______________________ _____________________ _________________

Supervisor’s name Signature Date

_____________________ ____________________ _________________

Name of Department Head Signature Date

College of Finance, Development and Management

Department of Development Economics

As members of the board of examiners, we examined this dissertation/thesis entitled “Factors

Figure 2.1: Conceptual framework factors affecting liquidity......................................................... 22

Figure 4.3: Loan Growth............................................................................................................ 31

Table 4.1: Summary of descriptive statistics

Table 4.2: Augmented Dickey-Fuller Unit Root Test

Table 4.3: Phillips -Perron Unit Root Test

Table 4.4: Correlation Matrix..................................................................................................... 35

Table 4.5: Variance Inflation

Table 4.6: Normality test

Table 4.7: Heteroskedasticity

Table 4.8: Breusch-Godfrey Serial Correlation LM Test

Table 4.9 Summary of Diagnostic test...................................................................................... 38

Table 4.11: Bound test

Table 4.12: Short Run estimation

Table4.13: Long Run estimation

BOA Bank of Abyssinia

NBE National Bank of Ethiopia

ADF Augmented Dickey-Fuller

ANOVA Analysis of Variance

ARDL Auto-Regressive Distributed Lag

BLUE Best Linear Unbiased Estimator

CAP Capital Adequacy

AIC Akaike Information Criteria

ECM Error Correlation Model

GDP Gross Domestic Product

NOA Number of ATM

NOB Number of branches

ATM Automatic Teller Machine

FEM Fixed Effect Model

1.1. Background of the Study

1.2. Statement of the Problem

1.3. Objectives of the Study

The specific objectives

1.4. Research Question

1.5. Significance of the Study

1.7. Limitation of the Study

1.8. Organization of the Study

2.1. Concepts of Banks Liquidity

2.2. What is liquidity at a bank?

According to business dictionary, liquidity is a measure of the extent to which a person or

_____________ _ _______

_____ _