The Effects Of Liquidity Risk On The Financial Performance Of Micro-Financial Institutions

Project and Seminar Topics with material for Banking and Finance

The Effects Of Liquidity Risk On The Financial Performance Of Micro-Financial Institutions


Abstract


Liquidity risk is inherent activities of micro finance banks due to the nature of their operations. The research sought to ascertain the effects of liquidity risk on the financial performance of micro-financial institutions which is the general objective. In line with this, the specific objective was to determine the effect of net loan holdings on the financial performance of micro finance banks in Nigeria, determine the effect of asset quality on the financial performance of micro finance banks in Nigeria, and determine the effect of liquid assets holdings to total assets on the financial performance of micro finance banks in Nigeria. The study was anchored on Liquidity Preference Theory, Shift Ability Theory and Financial Intermediation Theory to provide underpinning for the research. The research adopted causal research design where the study population comprised all the 11 listed micro finance banks licensed by CBN. The research used descriptive analysis and panel regression analysis for the data analysis. The panel regression analysis indicated that net loans holdings have a negative and significant effect on the financial performance of micro finance banks. Similarly, with respect to asset quality and financial performance of micro finance banks, the regression output revealed that the effect of asset quality on financial performance is negative and significant. On the effect of liquid assets holdings on financial performance of micro finance banks, the findings from the regression output indicated an inverse and significant effect of liquid assets holdings on financial performance of micro finance banks. The study recommends that banks should avoid having a large proportion or too much of their total assets in the long-term loans as this makes the banks illiquid, thereby hampering its profitability level. Also, the study recommends that proper credit risk management practices be put in place by banks. This is because poor credit risk practices are responsible for high levels of non-performing loans which ultimately and adversely affect the profits of micro finance banks.


Table of Content


Chapter One:

Introduction

  • 1.1 Background of the Study
  • 1.2 Statement of the Problem
  • 1.3 Objective of the Study
  • 1.4 Research Questions
  • 1.5 Research Hypothesis
  • 1.6 Significance of the Study
  • 1.7 Scope of the Study
  • 1.8 Limitation of the Study
  • 1.9 Definition of Terms
  • 1.10 Organization of the Study

Chapter Two:

Review of Literature

  • 2.1 Conceptual Framework
  • 2.2 Theoretical Framework
  • 2.3 Empirical Review

Chapter Three:

Research Methodology

  • 3.1 Introduction
  • 3.2 Research Design
  • 3.3 Target Population
  • 3.4 Sampling Design
  • 3.5 Empirical Model
  • 3.6 Operationalization and Measurement of Variables
  • 3.7 Data Collection Instrument
  • 3.9 Data Analysis and Presentation
  • 3.10 Diagnostic Tests
  • 3.10.1 Multicolinearity Test
  • 3.11 Research Ethics.

Chapter Four:

Results and Discussion

  • 4.1 Introduction
  • 4.2 Descriptive Analysis
  • 4.3 Multicollinearity Test
  • 4.4 Test for Fixed Effect of Random Effect
  • 4.5 Regression Analysis
  • 4.6 Hypotheses Testing and Discussion of the Findings
  • 4.7 Summary of Hypotheses Testing

Chapter Five:

Summary, Conclusion and Recommendation

  • 5.1 Summary
  • 5.2 Conclusion
  • 5.3 Recommendation
  • References

Chapter One


Introduction

1.1 Background of the Study

The financial sector has a vital role in modern trade as it has an important effect on any country economy (Akhtar et al., 2011; Iqbal, 2012). Globalization has led to attract the attention to the importance of financial and non-financial institutions. Considering the financial institutions, achievement of success and growth for most of banks in based on strategies of competitive marketing (Abugamea, 2018; Irshad et al., 2011). Such strategies are structured in the form of the activities done by the banking sector, which are included in the daily business transactions carried out by the banks. Such activities make banks subject to risk, represented in credit risk,liquidity risk, interest rate risk, market risk, operational risk, and others, which in turn affects banks’ profitability (Arif and Anees, 2012; Chen et al., 2018).

Profitability globally is of concern to various stakeholders which are creditors, owners, depositors, debtors, investors, regulators, bank managers and the government (Podder, 2012). However, the profitability of micro finance banks is dependent on their liquidity. Micro finance banks perform the major role of providing liquidity through their intermediation activities. Banks connect depositors and investors together by providing illiquid loans to investors (borrowers) where the liquid deposits kept by depositors are used to fund these loans. In performing this role, short term maturities are transformed by Micro finance banks into long maturities so as to create funding liquidity for the investors while promoting the effective and efficient resources allocation in banking industry (Maaka, 2013). Due to this, Micro finance banks are often characterized by maturity mismatch which causes instability for Micro finance banks in their roles as providers of liquidity upon depositors demand through deposit transactions, or the borrowers through loan application (Mwangi, 2014).

The banking industry in Nigeria has over the years witnessed various changes and transformation which include service innovations which are majorly technology based. The sector is characterized by globalization forces which seek to create growth opportunities. Similarly, there is the challenge for managers of banks to sustain profitability in the face of this increasing competition (Ibe, 2013). The maturity transformation roles of micro finance banks of converting short term deposits to long term loans brings about liquidity risk in the banking sector. It is hinged on the inability of micro finance institutions fund assets increases and address their financial obligations in due time, without having related losses. This risk is known as the possibility that micro finance institutions will not be able to meet their obligations in the short run when they arise which is because their inability to efficiently liquidate their assets or their inadequate funding sources (Decker, 2010).

Micro finance Banks liquidity risk is one of the most important risks affecting their activity, as evidenced by their inability to manage their commercial activities when there is a shortage in their liquidity, and they reach the point of bankruptcy when this shortage continues (Effendi and Disman, 2017). According to previous studies (Khursheed et al., 2016; Purbaningsih and Fatimah, 2014; Rasul, 2013), The bank’s financial performance is greatly affected by the liquidity risk that exists in any bank. Liquidity risk is measured by cash Ratio-CASR, current ratio-CURR, liquidity assets ratio-LAR and basic defense ratio-BDR (Anbar and Alper, 2011; Khursheed et al., 2016), while bank financial performance dimensions are measured by Return on Assets (ROA), Return on Equity (ROE) and Net Interest Margin (NIM) (Anbar and Alper, 2011).


1.2 Statement of the Problem

There has been a downward trend in the financial performance of of the micro finance banks in Nigeria (Toutou and Xiaodong, 2011), and this has become a great concern because the major role of the financial intermediation such as issuing of credits is made possible by the bank profits. Therefore the micro finance banks are not able to perform this role effectively and efficiently.

Globally, micro finance banks are fundamental in the allocation of economic resources of countries. These include but not limited to transferring funds from the possession of depositors to businesses and investors. micro finance do this by generating the necessary income to offset their cost incurred in the course of banking operations (Lyambiko, 2015). Also, the activities of micro finance banks are characterized by problems due to the fundamental role they play in short term deposit maturity transformation to maturity transformation of long-term loans which are exposed to liquidity risk. In such a scenario, micro finance banks are exposed to liquidity problems and the occurrence of such can frustrate their customers which can ultimately impact negatively on the financial sector at large (Kiganda, 2014).

In 2008 global financial crisis brought about the benefits of regulating banks in order to curb against the situation of high risks resulting from banks statements imbalances. As such, every bank has to ensure it works towards achieving its set profits target while at the same time satisfying customers’ financial demands by keeping an optimum level of bank liquidity. Therefore, liquidity has significant influence bank profitability which is negative in the event of a mismatch between bank assets and liabilities (Mwangi, 2014). This situation may result in exposing an institution to financial losses. Liquidity risk evolve from the processes in the operations of banks. It could adversely impact on the overall bank earnings and capital (Kazeem, 2015).


1.3 Objectives of the Study

The study generally focus on the examination of the effects of liquidity risk on the financial performance of micro-financial institutions.

The study will specifically assess the objectives below;

  1. Determine the effect of net loan holdings on the financial performance of micro finance in Nigeria.
  2. Determine the effect of asset quality on the financial performance of micro finance in Nigeria.
  3. Determine the effect of liquid assets holdings to total assets on the financial performance of micro finance in Nigeria.

1.4 Research Question

The study will be guided by the following questions;

  1. What is the effect of net loan holdings on the financial performance of micro finance in Nigeria?
  2. What is the effect of asset quality on the financial performance of micro finance in Nigeria?
  3. What is the effect of liquid assets holdings to total assets on the financial performance of micro finance in Nigeria?

1.5 Research Hypothesis

H01: Net loan holdings have no significant effect on the financial performance of micro finance in Nigeria.

H02: Asset quality has no significant effect on the financial performance of micro finance in Nigeria.

H03: Liquid assets holdings have no significant effect on the financial performance of micro finance in Nigeria.


1.6 Significance of the Study

Management of Micro finance banks is expected to have advanced knowledge on liquidity risk and bank profitability in Nigeria. This advanced knowledge will aid managers in formulating and implementing such important policies which will ensure high liquidity in the micro finance banks which will lead to increased revenues, thus giving the banks competitive edge.

The findings of this research are expected to furnish the banking sector with key policy recommendations that will curb the issues of low profitability. Therefore, providing policy recommendations that will aid the government with possible suggestions to liquidity risk and profitability in Nigeria micro finance banks.

By relating liquidity risk variables which are Net Loan holdings, Asset Quality and Liquid Asset Holdings to profitability of micro finance banks, the study would provide future researchers/scholars with an alternative measurement area which has little or no research within the micro finance banking context.


1.7 Scope of the Study

This study covers on the the effect of exchange rates changes on the performance on industrial banks in Nigeria using bank of industry as a case study.

The research will examine the effect of liquidity risk (Net loans to Total Assets Ratio, Non-performing loans to Total Loans Ratio and Liquid assets to Total Assets Ratio) on the financial performance of Nigeria micro finance banks. It focused on micro finance banks which are listed in Nigeria Securities Exchange (NSE). The study analyzed the secondary data as published in the banks’ audited financial reports ranging from 2013 to 2017.


1.8 Limitation of the Study

The perceived challenge for the study was based on the type of data that was used which is secondary data, there are different data’s. As such the issue of data authenticity becomes a concern. In addressing this limitation, the researcher ensured that that the research data is extracted from reputable sources such as Central Bank of Nigeria (CBN) and Kenya National Bureau of Statistics (NBS).


1.9 Definition of Terms

Liquidity Management:

This is a concept broadly describing a company’s ability to meet financial obligations through cash flow, funding activities and capital management.

Financial Performance:

This is subjective measure of how well a firm can use assets from its primary mode of business and generate revenue


1.10 Organization of the Study

This research work is organized in five chapters, for easy understanding, as follows Chapter one is concern with the introduction, which consist of the (overview, of the study), statement of problem, objectives of the study, research question, significance or the study, definition of terms etc. Chapter two highlight the theoretical framework on which the study is based, thus the review of related literature. Chapter three deals on the research design and methodology adopted in the study. Chapter four concentrate on the data collection and analysis and presentation of finding. Chapter five gives summary, conclusion, and recommendations made of the study.


Chapter Five


Summary, Conclusion and Policy Implications

5.1 Introduction

Chapter five presents the summary, conclusions and recommendations of the study. These are presented in line with the objectives and findings of the study.


5.2 Summary of the Study

Liquidity risk is dominant in the activities of micro finance banks as a result of the nature of their operations. The financial performance of micro finance banks is dependent on the major roles of credit creation performed by these banks. However, the provision of credit by micro finance banks is accompanied by liquidity risks. The research sought to ascertain liquidity risk effect on financial performance of micro finance banks. In line with this, the specific objective was to determine the effect of net loan holdings on the financial performance of micro finance banks in Nigeria, determine the effect of asset quality on the financial performance of micro finance banks in Nigeria, and determine the effect of liquid assets holdings to total assets on the financial performance of micro finance banks in Nigeria.

The study was anchored on Liquidity Preference Theory, Shift Ability Theory and Financial Intermediation Theory to provide underpinning for the research. The research adopted causal research design where the study population comprised of all the 11 micro finance banks licensed by CBN. The analysis of research data was based on descriptive analysis and panel regression analysis for the data analysis of the research.

5.2.1 Net Loan Holdings

On the effect of net loan holdings on financial performance, the study established that net loans holdings have a negative and significant effect on the financial performance of micro finance banks.

5.2.2 Asset Quality

On the effect of asset quality and financial performance of micro finance banks, the research revealed a negative and significant effect of asset quality on financial performance of micro finance banks.

5.2.3 Liquid Asset Holdings

With respect to the effect of liquid assets holdings on financial performance of micro finance banks, the study established a negative and significant effect of liquid assets holdings on financial performance of micro finance banks.


5.3 Conclusion

The conclusion of the research is guided by the findings of the study. The findings of the study are in line with the specific objectives of the study. The study found a negative and significant effect of net loans holdings on financial performance micro finance banks. Therefore, the study concluded that increase ratio of net loans to total assets is detrimental to the financial performance of banks. The financial performance of micro finance banks is hampered by high levels of net loans.

Secondly, on the effect of asset quality and financial performance of micro finance banks, the study concluded that higher ratio of non performing loans to total loans inversely affects the financial performance of banks. Non performing loans are written off against bank profits, therefore, the higher the proportion of non performing loans to total loans, the more the depletion of the profitability of banks.

Lastly, on the effect of liquid assets holdings, the study found a negative and significant effect of liquid asset holdings on financial performance of micro finance Banks. Therefore, the study concluded that increase level of liquid assets especially highly liquid assets brings about the depletion of the financial performance of micro finance Banks.


5.4 Recommendations

  1. Micro finance banks should avoid having a large proportion or too much of their total assets in loans as this makes the bank illiquid, thereby hampering its financial performance.
  2. Proper credit risk management practices be put in place by banks. This is because poor credit risk practices are responsible for high levels of non performing loans which ultimately and adversely affect the profits of commercial banks.
  3. Micro finance banks should avoid holding too much liquid assets as the highly liquid assets are associated with lower returns than risky assets. As such, the opportunity cost of having too much liquid assets outweighs the return it generates. Therefore, optimum liquid assets to total assets ratio is recommended.
  4. Micro finance banks hold more liquid assets in periods of poor economic conditions. It is therefore advisable for the management to pay the required attention to the liquidity management.

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