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THE IMPACT OF LIQUIDITY MANAGEMENT ON DEPOSIT MONEY BANKS’ PERFORMANCE IN NIGERIA

ECONOMICS PROJECT TOPICS AND MATERIALS

CHAPTER ONE

INTRODUCTION

  • Background to the study

The unique role of banks as engine of growth in any economy has been widely acknowledged. Banks occupy central position in the country’s financial system and are essential agents in the development process. The intermediation role of banks can be said to be a catalyst for economic growth as investment funds are mobilized from the surplus units in the economy and made available to the deficit units. By intermediating between the surplus and deficit units within an economy, banks mobilize and facilitate efficient allocation of national savings, thereby increasing the quantum of investments and hence national output. Banks as financial intermediaries provide avenue for people to save incomes not expended on consumption. It is from the savings accumulated that they extended credit facilities to the entire economy. To perform their role effectively deposit money banks (DMBs) have to be adequately liquid. This implies that the survival of deposit money banks depends largely on its liquidity, because illiquidity being a sign of imminent distress can easily erode the confidence of the public in the banking sector hence sound liquidity is inevitable.

 

Liquidity management helps deposit money banks to maintain stability in operations and earnings by serving as a guide to investment portfolio packaging. Effective liquidity management serves as a veritable tool through which deposit money banks maintain the statutory requirements of the central bank as it affects the proportion of deposits to liquid assets and deposits to loans and advances. Liquidity management reduces the incidence of bankruptcy and liquidation which can be the later effect of illiquidity, and help them to achieve some margin of safety for their customers’ deposits. Adequate liquidity helps banks to sustain public confidence of the depositors and the financial markets. Liquidity management assists banks in trading off between risk and return; and liquidity and profitability. It serves as a tool through which deposit money banks avoid over liquidity and under liquidity and their consequences. It also enables the banks to avoid forced sales of unfavourable and unprofitable venture or its assets to generate cash. It is for this reason; governments of countries through their apex bank and other relevant authorities formulate reform policies and programme for banking industry (Olagunju, Adeyanju, and Olabode 2011).

 

The importance of accurate liquidity management cannot be over stressed as it reveals the liquidity positions of the banks through which the operators of the financial market and other creditors adjudged the credit worthiness of the banks. Liquidity management requires an appraisal of holdings of assets that may be turned into cash. The determination of liquidity adequacy within this framework requires a comparison of holding of liquid assets with expected liquidity needs.  The stock concept of liquidity management is widely used and involves the application of financial ratios in the measurement of liquidity positions of deposit money banks. One of the financial ratios used in such measurement is liquidity ratios which measures the ability of the bank to meet its current obligations. Other ratios which have been developed to measure liquidity are liquid assets to total assets; liquid assets to total deposits; loans and advances to deposits. Calculating the ratio of liquid assets to total assets explains the importance of a bank’s liquid assets among its total assets. It indicates the proportion of a bank’s total assets that can be converted into cash at a short notice. Cash ratio to total deposits or assets is another measure of bank liquidity. Its advantage over others is that liquid assets are related directly to deposits rather than to loans and advances that constitute the most illiquid of banks assets.   The ratios serves as a useful planning and control tool in liquidity management since deposit money banks use it as a guide to extend credit to the economy ( Olagunju,  Adeyanju , Olabode 2011).

 

In an attempt to enhance adequate liquidity the Nigerian government through the monetary authorities have implemented various policies reforms and regulations in banking sector. Such policies and regulations include: The introduction of the 1952 Banking Ordinance which imposed entry conditions for banks in Nigeria. For the first time, indigenous banks were required to have a minimum paid-up capital of £12,500 while foreign banks were required to have a minimum paid-up capital of £100,000. Banks were also required to maintain a reserve into which a minimum of 20 percent of their annual profits had to be paid. The 1952 Banking Ordinance was however ineffective in managing banking liquidity (Nwankwo 1980).

 

The 1952 Banking Ordinance did not make any provision for assisting banks as there was no Central Bank to act as lender of last resort. The Banking Ordinance of 1958 was subsequently enacted, establishing the Central Bank of Nigeria. The 1958 Banking Ordinance raised the minimum statutory reserve from 20 percent to 25 percent of annual profits; maximum lending to 20 percent of the sum of paid-up capital and statutory reserves; and specified a list of acceptable liquid assets. The 1958 Banking Ordinance was amended in 1962; the amendment raised the minimum paid-up capital of indigenous banks from £12,500 to £250,000 while foreign banks were required to maintain a minimum of £250,000 worth of banks assets (Ajayi and Ojo 1981).

 

The 1958 Banking Ordinance and its 1962 amendment were repealed in 1969 and replaced by the Banking Act of 1969. The Banking Act of 1969 empowered the CBN to stipulate minimum holding by banks of cash reserves, specified liquid assets, special deposits and stabilization securities. The maximum lending to a single borrower was also increased from 20 percent to 33.3 percent of the paid-up capital and statutory reserves.

 

IMF supported Structural Adjustment Programme (SAP) was introduced in 1986 in order to encourage competition and market led resource allocation. NCEMA (2003) explain that SAP “relies on market forces and the private sector in dealing with the fundamental problems of the economy.” The package of financial reforms introduced during this period led directly to an increase in deposit money banks from 40, before 1986, to 120 in 1992. In 1990, entry into the Nigerian Banking Sector was further liberalized as foreign banks were allowed to open offices in the country. CBN Decree 24 and the Banks and Other Financial Institutions Decree 25 both of 1991, which repealed the Banking Decree 1969 and all its amendments were thereafter enacted to strengthen the power of CBN to cover new institutions in order to enhance the effectiveness of monetary policy. By 1998, however, the number of deposit money banks in operation whittled down to 89 when the monetary authorities liquidate thirty (30) terminally distressed deposit money banks.

 

In addition, other frantic efforts were made to enable banks to perform optimally. These include the establishment of the Nigerian Deposit Insurance Corporation (NDIC); Banks and Other Financial Institutions Act (BOFIA) No. 25 of 1991; and the introduction of Prudential Guidelines in strengthening the regulatory and supervisory institutions. The Removal of Credit Ceilings and upward review of capital adequacy standards were also enacted. Also, the introduction of Prudential Guidelines in 1990, increased minimum paid-up capital requirements of deposit money banks from N20 million to N50 million in 1992, N50million to N500 million in 1998 and N500 million to N2 billion in 2002. For banks to become stronger in liquidity, perform better, become more competitive and contribute to the Nigerian economy and attain a global standard, the “mother” of reforms was carried out in 2004. The minimum paid-up capital for deposit money banks was increased from N2 billion to N25 billion (Iganiga, 2010).

 

The relationship between liquidity management and deposit money banks’ performance is on the notion that well articulated liquidity management in banking industry will improve deposit money banks’ performance. This will in no small measure improve the asset base of deposit money banks and make more credit available to the economy.

 

1.2      Statement of the Problem

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