CHAPTER ONE

INTRODUCTION

1.1 Background Of The Study

Liquidity creation is the primary function of bank but also a major source of vulnerability. The vulnerability form their primary function requires deliberate policies and actions by the bank to mitigate against such risks  (Dybvig (1983), Bryant (1980)). A bank is liquid when it is capable of meeting its own obligation when they become due, repay deposit and to make such payment on customer order.

Liquidity can be defined as the assets or securities which can be easily convertible into cash. Liquidity refers to the short term assets (Cash, short term, advances, and balance with other bank) and short term liabilities (short term borrowing, account payable, lending to financial institutions, and short term deposit). Liquidity management is essential for bank effectiveness and profitability. On the other hand profitability means a situation where revenues exceeds expenses and which allow bank to generate profits (Bawacha (2018).

It is important to determine the relationship between liquidity and profitability (Sile and al ( 2019), Ibrahim ( 2017), Mazrova ( 2015). Indeed we attempt to study the impact of liquidity on bank profitability in Tunisian context. We will use approach that consists of 3 sections. First, we will show the literature review, and then we will analyze the empirical study. At the end, we will make the conclusion

According to Bagh, et al. (2017) “the Banking sector serves as a backbone for an economy, and occupies a paramount important place in the development and growth of country’s economy. Banks serves as an intermediary to all industries ranging from textile, cotton, agriculture, small and medium enterprises, manufacturing, construction, starts up finance and many more one way that in turn contributes straight a way to the national income and growth and development of country largely depends on sound foot holding of the banking system of a country.

It acts as a role of nucleus for smooth working of economic undertakings with in a country and from corner to corner of the world, and eventual rebuilding and innovation in the industry has upstretched the standard of living”. According to Eljelly, (2004) the conception of liquidity management is getting a thoughtful consideration across the world, principally due to current financial circumstances.

Moreover, Panday, (2005) Liquidity management is surrounded by the four cardinal decision domains of corporate finance management that entails meticulous administration, planning, and management to be a successful enterprise.  According to Kashyap et al., (2002) for banking sector the long tenure of advancing, construct liquidity impediments. Rehman at el., (2015) stated liquidity and profitability both are most bulbous issues in the realm of corporate fiancé and the theme of liquidity is not straight to define.

Based upon these phenomena the cushion is available for research on liquidity management practices. The terms liquidity is defined by Nwaezeaku (2008) as the degree of convertibility to cash or in other words the ease with which any assets can be en-cashed or converted to cash is called liquidity in financial literature. He also added that assets must be sold at a fair market price. Nahum et al. (2013) advocated that the dilemma in connections with liquidity management is to attain the desired trade –off between profitability and liquidity.

In accordance to Niresh (2012) liquidity management is regarded as a prerequisite in order to make sure that the firms are capable to meet their short term business obligations effectively. He also added that liquidity always plays a vital role as far as the successful operation of the business is concerned. Ibe, (2013). Liquidity can be categorized as the straightforwardness with which an advantage can be changed over into money.

Bank liquidity implies having adequate money to meet the commitments. It is banks capacity to rapidly meet money, checks and other withdrawal commitments.  Akter and Mahmud, (2014) indicated availability of money to meet everyday maneuvers of business is called liquidity. Liquid resources are easily converted over into money.

According to Arif and Anees, (2012) Liquidity difficulties may deleteriously affect a certain bank’s earnings and capital. Under risky situations, it may become reason of failure otherwise solvent bank. Another hurdle may be meeting the depositor’s demands. The highest priority of a bank’s management is to pay the necessary consideration to the liquidity difficulties.

These difficulties should be taken into consideration in timely manners and immediate affirmative and corrective actions should be taken in order to avoid the significances of illiquidity. The study is around the impact of liquidity on the profitability of commercial banking sector of Pakistan. When the banks have sufficient money to meet day to operation is called liquidity. Bank liquidity implies having enough money to meet the commitments.

1.2 Problem Statement

The turbulence in the credits and funding markets since 2007 is sufficient evidence that liquidity risk management in the banking system has been less effective than expected. According to the Financial Stability Review (FRS 2008), investors appear to have acquired risks, which they did not fully understand that major financial institutions were not able to manage these risks so much as transferring them into their own business lines resulting in an unintended concentration of risks on their own balance sheet.

Banks offer a menu of contracts to depositors and loans to firms which are intended to suit with expected liquidity needs of agent. In the study of impacts of liquidity constraints on bank lending policy, Webb (2000, p.70,71) points out that in an advent of poor information of liquidity risk management from a bank, depositors of fund will choose to withdraw a greater portion or even all of their deposits, causing liquidity shortfall, which banks will be unable to generate sufficient financing to embark on profitable projects and consequently affect performance ratios such as assets turnover and return on equity.

Recent research related to liquidity management reckons that managing liquidity risk requires banks to have sufficient liquidity to meet up with depositors and investors demand of funds (not too much, not too less but sufficient only). That bank creates liquidity by transforming illiquid loans into demand deposit which is given to investors in the forms of credits lines and loans commitment to invest in the markets of securities hence creating markets liquidity.

Ford (2009, p.46, 47) argues that stress testing in analyzing the future possibility of liquidity exposure, management oversight and contingency planning will help to mitigate the liquidity risk and ensure stability in the system.

Bikker and Hu (2002) revealed that African banks have not been widely studied and was therefore difficult to inform policy on readily efficient banks in the continent without sufficient data. A similar view was reached by Roland (1997), Eichengreen and Gibson, (2001), Goddard et al. (2004), Gibson (2005), Bonaccorsi di Patti.

All these studies, among others observed that more understanding on Cameroon banking sector performance was important. World Bank (2005) also emphasized the need to undertake deeper anlysis of financial sector performance in SSA, where performance has not been impressive. This study however is structured to give answers to the following main questions:

What is the role of liquidity and profitability management in commercial banks.

1.3 Research Question

The main objective of this study is to answer the following question as stated below;

1. What is the nature of the relationship between bank liquidity management and bank profitability?
2. To what extent has the volume of bank cash influenced bank profitability?
3. Is there any effects of liquidity management on profitability of banks?

1.4 Research Objectives

The objective of this study is to measure how liquidity management can affect the profitability of a financial institution

1. To scrutinize the impact of liquidity management on the profitability of financial institution
2. To pinpoint the status or impact of liquidity management practices on profitability of financial institution

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