LIQUIDITY MANAGEMENT IN BANKS: A STUDY OF SELECTED COMMERCIAL BANKS IN NIGERIA (2000-2009)

Background of the study: The whole concept of banking is built upon confidence in the liquidity of the bank. Liquidity management is critical in the banking operations. Customers place their deposits with a bank, confident that they can withdraw the deposit when they wish. If the ability of the bank to pay out on demand is questioned, all its business may be lost overnight. Generally speaking, liquidity refers broadly to the ability to trade instruments quickly at prices that are reasonable in the light of the underlying demand/supply conditions through depth, breath and resilience of the market at the lowest possible execution cost. A perfectly liquid asset is defined as one whose full present value can be realized, i.e. turned into purchasing power over goods or services. Cash is perfectly liquid, and so for practical purposes are demand deposits and other deposits transferable to third parties by cheques and investments in short-term liquid government securities.  Adequate liquidity enables a bank to meet cash withdrawal commitments when due, undertake new transactions when desirable, and discharge other statutory obligations as they arise.  Liquidity is the term that best describes the ability of a bank to satisfy the demand for cash in exchange for deposits. The most important aspect of liquidity function in banks is that it helps to sustain the confidence of the depositors, who should not be given any cause to doubt the safety, solvency and viability of the bank. A bank is considered liquid when it has sufficient cash and other liquid assets to off-set its obligations readily or assets to sell at short time notice, without loss in value.

Bank’s liquidity can also be measured by its ability to raise funds quickly from the other sources such as money markets to enable it honour maturing/payment obligations, and commitments without notice. Banks are statutorily required to comply with the legal cash and liquidity ratios reserve requirements so as to cope with the demands of its financial obligations owed to its customers and other stakeholders.

 However, the level of liquidity to hold and in what forms to preserve them pose serious task to the bank management. The majority of banking transactions can be anticipated in advance from the expected cash flows, deposits and earnings from loan repayments. Banking business is associated with elements of risks and for which no adequate provisions are often made to accommodate any obvious shortfalls, arising from the defaults on loan repayments.          

  It is for this reason that this study seeks to examine the need for keeping adequate liquidity to serve as a ‘buffer’ to cushion the effects of deposits fluctuations and compensate for the gap during periods of emergency.

  Basically, liquidity management seeks to strike a delicate balance between the need to maintain sufficient liquidity to meet depositors’ cash calls. Illiquidity jeopardizes ability to service customers’ withdrawal demands while excess liquidity erodes the earning capacity and profit performance of the banks.  Liquidity Management therefore appears more crucial than any other aspects of bank management like bank marketing, because negative signals of illiquidity in a bank cannot be hidden for too long.

In Nigeria, the activities of the commercial banks are subjected to the extensive prudential regulations under Banks and Other Financial Institutions Act 1991 (BOFIA). The essence of these regulations is to maintain trust, stability and public confidence in the banking system.  The commercial banks in Nigeria are mandated to keep certain percentage of their cash as legal reserve.   Experience in Nigeria has shown that most commercial Banks run into problems of illiquidity because of assets mismatch, excessive risks concentration on portfolio investments, massive fraud and other insider -related abuses.