Profitability And Liquidity In Commercial Bank

Project and Seminar Material for Accountancy / Accounting

Abstract

This is a work based on a topic which has been critically viewed by many people as an area which has been under serious treat in recent years. The banking industry has for some times come under heavy supervision as to whether there should be any reliability on the industry or is it just collecting money from people today and then go in to distress, the next day. With the help of this reform program, the central Bank of Nigeria (CBN) has on July 2004 announced a major reform program aimed at transforming the banking landscape of the country. The main thrust of the 13 point reform agenda then was the prescription of minimum shareholder’s funds of 25 billion not later than December 31 2005. Also the central bank of Nigeria (CBN) announced on the 1st of January 2006 that 13 out of 89 banks failed to meet its 25 billion capitalization target and therefore is to be liquidated. And then the number of banks that emerged at the consolidation exercise was 25 banking groups, and Zenith Bank which is my case study. This work is to bring to memories of people the role the banking industry plays and they generate its revenue, and expenditure. Furthermore, it went ahead to establish a firm prove on the relationship between profitability liquidity in commercial bank.

Chapter One

Introduction

1.1 Background Of Study

Banking in Nigeria has gone through very dramatic changes, since the appointment of (professor charles soludo) as the new Governor of central bank of Nigeria on Tuesday 6th of July 2004 signaled the beginning of a revolution in the Nigerian Banking industry. Before the appointment of (Professor Charles Soludo) C.B.N pronouncement was that the operation of the banking system was nothing to write home about, indeed the banks were rated sound and satisfactory. While 25 were rated marginal and unsound, exhibited weakness ranging from under capitalization and solvency, weak and poor assets quality, poor earnings, management illiquidity.

To put things right and ensure a sound banking system for Nigeria (Soludo) proposed a 13 point banking reform programme that anchored on the following.

– Capital base requirement of N25 Billion through consolidation of Bank via merger and acquisition by December 31st 2005 etc. To create a safe banking system, the apex bank must have been encouraged by the fact that global size has become an important ingredient for success. Furthermore an enhanced capital base given a bank a competitive edge enables it to acquire relevant technology to engage high quality personnel to absorb cost to provide better services and ultimately increase in its earning although the 25 billion minimum capitalization requirement and the bank consolidation exercise is meant to create a sound banking system that depositors can trust, it does not necessarily guarantee or address the observed weak corporate governance practices excessive risk taking poor credit policies and administration loans Nigeria banking system.

The reform of the banking system is the right panacea the country needs for the industrial take off. This is in view of the fact that banking system plays a critical role in the economic growth and development of a country.

According to Prof. G. O Nwankwo, (1991), since they are the providers of the means of payment a failure in banking system could have a devastating consequences on the economy especially as financial institutions and markets are key intermediaries through which government bring their macro economic activity.

In banking transactions, the commercial banks operate on a profit. Motivated basis that is their sole aim of being in operation is for profit maximization and they try to make their shareholders happy by recording huge profit in their financial report every year. Banks represent a significant and influential sector of the economy and play a major role in the monetary system. There is, therefore considerable and widespread interest in their management and performance.

The quality of their financial statement will help to foster public confidence in the banks as well as in evaluating their performance.

A little history of banking in Nigeria needs highlighting to enable us form a firm understanding of the business generally. Modern commercial banking in Nigeria dates back to early colonial period. The decline in barter system of trade and the rise in financial transactions of the colonial government required on institution in the form of a commercial bank for safety and transmission of funds it was for this purpose that African Banking corporation based in South African was invited in 1892 to open a branch office in lagos.

The African banking corporation was therefore the first modern commercial bank to open a branch office in Lagos but its existence was made precarious by the trade depression, which hit lagos in that year. In the years 1894 its operation were taken over by the bank of British for West Africa. Later, its name was changed to standard Bank for West African Ltd. In compliance with the company’s act of 1968, this pioneer expatriate bank has incorporated in Nigeria s the standard bank of Nigeria Ltd. The bank changed its name was changed his name in 1978 to first bank of Nigeria limited Liability company (PLC). We have also another one called Barclays Bank (Dominion Colonies overseas) which came into Nigeria banking scence in 1917. Through also the companies Act of 1968, the bank changed its name to Barclays Bank of Nigeria limited. And in 1978 it was re-named Union Bank of Nigeria which is now a public limited company.

There were few of these banks that were purely indigenous right from outset which represent the effort of Nigerian business men to establish their own banks since the expatriate banks have not been particularly interested in giving them assistance they normally require to manage their own business.

In order to break the monopoly of the colonial banks indigenous banks Mushroomed, in the absence of a banking ordinance to regulate banking business. The first attempt to establish an indigenous bank was in 1929. Indigenous West African businessmen resident in London required a bank in London and transferred its operations to Lagos.
Because of bad management the industrial and commercial bank folded up in 1930. The Nigeria Mercantile Bank founded in 1931 collapsed in 1936, but the relational bank of Nigeria founded as a public company in 1933, survived an early collapse apparently because of prudent financial management.

Between 1947 –1952, well over twenty banks sprang up in the country. Almost all the mushroom banks formed during that period, as most of them were little different from wayside football ditch filed away before December 1959 because of:

Absence of a Regulatory authority and lender of the last Resort
Under capitalisation and over branding
Poor customer patronage
Poor liquidity
Poor quality manpower.

The government as a result of its concern over the menace and potential danger posed for the nations economy by unregulated banking industry (as evidence by the crop of mush room banks), issued its first banking ordinance in May 1952. The ordinance required thus

New banks incorporating in the country to have a minimum normal capital of N50,000.00
New Banks to incorporate with a minimum paid-up capital of N25,000.00
Foreign bank not incorporated in Nigeria to show evidence of paid-Up capital of N200.000
All new banks to obtain a licence from the finance secretary before operating.
At least 20% of profit must be paid into the banks reserve until the value of reserve is equal to the paid-up capital.

In 1991, two new banking legislations were passed in Nigeria. They are central Bank of Nigeria Decree N0.24 and the banks and other financial institutions Decree N025. the banks and other financial institutions Decree (BOFID) which replaced the 1969 banking Act and all its amendments, distinguished between the use of the word “Bank which applies to the central Bank of Nigeria and the word “bank” which applies to other banks. It went ahead to define the word “bank” as a bank licensed under the banks and other financial institutions Decree 1991. therefore, BOFID 1991 defines banking business as “the business of receiving deposits on current account, saving account or other similar account, paying or collecting cheques drawn by or paid in by customers: Provision of finance or such other business as the governor of (the C.B.N) may by order published in the Gazette.

In the past people might have been carrying on banking business without any licence, but now it is not so. Specifically, section 2(1) of the BOFID 1991 state that “No person shall carry on banking business in Nigeria except it is a company dully incorporate and holds a valid banking business to carried out in Nigeria. It must be licensed according to the laws. Then, for a commercial bank, the bank and other financial institutions Decree 1991, defines it as “any bank in Nigeria whose business includes the acceptance of deposits, withdraw-able cheques. This is the major destination between category of bank of banks and others only the commercial Kingdom, they are simply referred to as clearing banks. One striking feature about the ownership of Nigerian commercial bank is the state and federal government participation in Nigeria banking dates back to 1952 when two states government came to rescue the three them surviving indigenous banks. The Eastern Regional Government rescues the African Continental Bank, and Aghonmaghe bank (now Wema bank) were rescue by the government of Western region.

The Federal government on the Other hand came into banking business participation in 1974, when the federal government required 40% share in “Big three” expatriate banks. The standard Bank of Nigeria (Now first Bank) Barclays Bank of Nigeria (now union bank) and United Bank of African. The Federal Government later increased their share holding to 60% in 1976. All these are in a bid to check the activities of these banks.

Since the C.B.N. Decree No. 24 of 1991 and the other financial institutions Decree No 25 of 1991 came into being more laws relevant to a sound banking operation have been promulgated, they included.

Failed Banks (debt Recovery) and other financial malpractice Decree No. 18, 1994:
Money laundering Decree No. 3 1995 and
Foreign exchange (monitoring and miscellaneous provisions) Decree No. 17 1995.

The three decree, though promulgated for purposes different from the CBN Decree No 24 and BOFID No. 25 both of 1991, have helped to sanitized banking operations in Nigeria, which is also a main objective of C.B.N. Decree No. 24 and BOFID No 25 the federal government in its 1997 budget mandated commercial banks to increase their mandatory minimum equity capital requirement to N500,000,000 (five hundred million). By 1999 the minimum capital of new banks was raised to N1 billion. By 2001 minimum capital was further raised to N2 billion for new banks. And the new regulation according to Charles Soludo the C.B.N Governor 2004 during financial institution summit held at Abjua on 6th of June 2004 has directed all commercial banks to increase their minimum capital from N2 billion to N25 billion by December 2005 with this new directive, the banks will have enough equity capital for its transactions thereby leasing the rampant eases of distressed banks in the economy.

1.2 Statement of Problem

Commercial banks as we know have a role to pay in the economy, which is seen by investors and lenders of money as an in evitable function or activity necessary for the development of the economy. It is a well know fact that commercial banks are profit oriented and to commercial bank management this has been a never-ending “tug of war”.

This war is pitched between liquidity and safety on one hand and earnings and profitability on the other hand. Prof. Nwankwo G. O (1988) P 8-10 “commercial bank is like a servant serving two masters at the same time”
The liquidity of a bank, hence its safety is necessary because of the nature of its liabilities. A high proportion of the commercial banks liabilities are made up of demand deposit (current accounts deposits and savings deposits) with all these in view we see that the banks have enormous responsibility they encounter problems that tends to stop their existence.

The following are factors that constitute current threats I challenges to the commercial banks.

There is a high cutthroat competition among banks.
There is lack of consistence and severe policies
Lack of appropriate management techniques and laxity on the banks
A lot of fraud and fraudulent practices gong on in the industry
There is high level of bad (indigenous lending.
Recruitment of staff based on personnel connection instead on merit.
The banking industry is highly regulated to a point of conflicts on the regulation

1.3 Objectives of the Study

The following are the aims of the study

To determine if there is a definite relationship (direct or inverse or no relationship) between the liquidity and profitability.
To find out the performance level of the bank (Zenith Bank) which yields a huge.
To ascertain if highdebts pose a serious and injurious threat to the banks.
To determine whether the banking sector are closely regulated and monitored.

1.4 Research Question

Are there fraudulent practices in the banking industry?
What gives rise to high bad debt/injudicious lending in the industry?
Is the banking industry highly and closely regulated?

1.5 Research Hypothesis

The belief that the liquidity and profitability are related, as one rises the other falls, liquidity determines profitability of an asset. But in Nigeria the reverse tends to be the case.

The null hypothesis (HO) and my alternative hypothesis (Hi) are formed on these bases.

H0: There is no significant relationship between profitability and liquidity in commercial banks.
H1: There is a significant relationship between profitability and liquidity in commercial banks.
H20: There is no significant relationship between bad debts and profit decline in commercial banks.
H21: There is a significant relationship between bad debts and profit decline in commercial banks.

1.6 Significance of Study

My intention in carrying out this study is to make little contribution to the already over-screeched issue. The major significance so to say is to educate, highlight and bring to focus the basic and conflicting rudiment of commercial bank fund management and the banking operation in existence. I noticed a near absence of information or facts on figures about the profitability of commercial banks in Nigeria. Most writers try to concentrate on the liquidity of the operation but I want to compare the liquidity level of commercial banks as against its profitability and then bring out their relationship. Based on this knowledge the intention to make a more balanced study on this aspect of commercial banking operations, via profitability and liquidity.

1.7 Scope of Limitations of Study

The scope of this study is very wide if it has to be carried out in all commercial banks in Nigeria. But, in this type of study, which involvesanalysing the bank statements or its annual report on its activities, the amount of data available and its type obviously limit the extent of and the through of analysis. Information and data available are basically secondary and in fact final figure as reported by the bank is near impossible because of the general attitude of hoarding information by banks management and staff. They said, it was for security purpose, hence the study is limited to few selected banks.

1.8 Definition of Terms

Profitability:

Is the measure of the level of income which a bank earns from its operations, residue earnings, after charging interest paid out, total expense, taxes etc.

Vis-à-Vis:

This is Latin word, which is used in comparison between two relative factors. That is, how one factor affects the other in relation to the output or outflow?

Bank Run:

Is a situation where the knowledge of an impending liquidity arises, typically ignited when some banks failed, it causes frightened depositors in others banks to reach in to withdraw the deposits.

Equity Capital:

This is the required capital, which is expected of every bank to have before commencing banking transactions. It also called the authorised capital.

Window Dressing:

This is an idiomatic expression, which means that banks, normally, give false financial report about their banks, thereby stating huge profit when in actual fact, the made little or no profit.

Share Capital:

Share capital shows the contribution in the form of total per value of share held by the owner share holders of the bank. Share capital most of which are ordinary shares, are issued out to the public who then subscribe and pay the money value of the shares allotted to them.

Share Premium:

Is the margin placed about the nominal value of a share due to the attractiveness of the shares to the buying public.

Reserves

Represents amounts set aside for some purposes. Statutory re-services are the amount of money that is stipulated by law to be set aside out of profits. There are also revenues, profits. There are also revenues and capital reserves, profit and loss account.

Long-Term Liabilities

Debentures or loan capital are medium or long-term focus to bank the banks credit expansion.

1.8 Organization of the Study

The study is divided into five chapters. Chapter one deals with the study’s introduction and gives a background to the study. Chapter two reviews related and relevant literature. The chapter three gives the research methodology while the chapter four gives the study’s analysis and interpretation of data. The study concludes with chapter five which deals on the summary, conclusion and recommendation.

Chapter Five

Summary, Conclusion and Recommendation

5.1 Introduction

It is important to reiterate that the objective of this study was to examine profitability and liquidity in commercial banks.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which are coined from the findings of the study.

5.2 Summary

This study had attempted to investigate liquidity and profitability in commercial banks with focus on Zenith bank.Findings from the testing of hypothesis indicates that there is significant relationship between liquidity and profitability. That means profitability in commercial banks is significantly influenced by liquidity and vice versa. This is indicated by 19.331 of chi-square statistical method, which confirmed the positive relationship between the two variables. In support of the findings, ninety (90) respondents indicated that there is a significant relationship between liquidity ratio andprofitability while 43 respondents indicated a nay response. It was also revealed that profitability will be optimized only when liquidity is effectively and efficiently managed i.e. when the commercial bank is able to meet its financial obligations and at the same time maximizes its profits. A situation where the commercial banks maintain more than the required liquidity level, the result will be huge stock of idle stock in the vault at the expense of profitability. This was exactly the situation for most of the studied commercial banks. One can then conclude that the declared profits after tax of these commercial banks within the period under study were below optimum level because of excess idle cash they maintained.

5.3 Conclusions

Liquidity management and profitability in commercial banks are two sensitive issues in the operations of commercial banks and of which information on them are seriously hoarded. Consequently, a study on these two issues was not coming too easy. The major concern of this study was to reconcile the conflicting requirements of bank liquidity and bank profitability arising from the conflicting desires of the two major providers of the bank resources namely the shareholders and the depositors. The shareholders desire maximum profitability as a return on their capital, while the depositors opt for a maximum liquidity as a guarantee for safety and ability to pay their money on demand. Considering the findings of this study, the following conclusions can be drawn:

For the success of operations and survival, commercial banks should not compromise efficient and effective liquidity management. They are expected to maintain optimal liquidity level in order to satisfy their financial obligations to customers or depositors and maximize profits for the shareholders.
The optimal liquidity level is reached if the commercial banks religiously maintained the minimum liquidity requirement as stated by the Central Bank of Nigeria. This attempt helps to reduce cases of bank distress.
From the study, we can rightly conclude that both illiquidity and excess liquidity are “financial diseases” that can easily erode the profit base of a bank as they affect bank’s attempt to attain high profitability-level. The pursuit of high profit without consideration to the liquidity level can cause great illiquidity, which reduces the customers’ patronage and loyalty. Therefore, any bank that has the aim of maximizing its profit level must adopt effective liquidity management.
Effective liquidity management also requires adequate liquidity level which will help commercial banks to estimate the proportion of depositor’s funds that will be demanded at any period and arrange on how to meet the demand. It can finally be concluded that liquidity is inversely related to profitability. That means as liquidity increases, profitability decreases and vice versa.

5.4 Recommendations

Based on the critical evaluation of the above findings, the following recommendations are made with the sincere conviction that they will help to reduce if not totally eradicate the problems associated with liquidity management and profitability in commercial banks.

Since the survival of commercial banks depend on liquidity management and profitability, they should not solely concentrate on the profit maximization concept but should also adopt measures that will ensure effective liquidity management. The measures will help to minimize or avoid cases of excessive and deficient liquidity as their effects.
Instead of keeping excessive liquidity as a provision for unexpected withdrawal demands of the customers, the commercial banks should find it reasonable to adopt other measures of meeting such requirements, which can include borrowing and discounting bills. In addition, the surplus funds of the commercial banks should be seasonally invested in short-term instruments of the money market.
For the fact that the monetary policies of CBN grossly affect liquidity management of the commercial banks, CBN should take the interest of the later into consideration while establishing and implementing these monetary policies in general and the liquidity ratio in particular. To achieve this feat, CBN is expected to create a forum whereby its policy makers and the management of commercial banks interact and dialogue for acceptable monetary policies.
The Central Bank should be encourage maintaining a flexible Minimum Monetary Policy [MPR] or discount rate so as to enable the commercial banks take advantage of the alternative measures of meeting the unexpected withdrawal demands, and reduce the tendency of maintaining excess idle cash at expense of profitability.
The monetary authority should as a matter of urgency encourage and legitimate the use of credit cards and enforce cheque usage for huge amounts in the day to day business transactions. This action will go along way to remedy the problem of maintaining huge idle cash in vault in expectation of unprecedented withdrawal, as the movement of cash will be highly reduced. In addition, CBN should institute the most efficient and effective clearing system, which will play supporting and facilitating role for the use of credit cards and other electronic money transfer, as it is done in most advance countries.
Commercial banks should schedule the maturity periods of their secondary reserve assets to correspond to the period in which the funds will be needed.
The commercial banks should create a customer forum where their customers will be educated on varieties of deposits and the operational requirements of each of them. A situation where the customers operate any of the deposits as required, the commercial banks will be able to estimate the liquidity level to be maintained.
Further research is recommended on how to achieve the optimal liquidity level in commercial banks. The result will help to solve the problem of excess liquidity and its reducing effects on profits, and arbitrary high profitability with its consequent reduction of liquidity position. Also it is recommended that research should be launched on identifying better quantitative measures of profitability, liquidity, risk and managerial efficiency, which could lead to more satisfactory estimation of cause-effect relationship.
It is finally recommended that interested researchers should dwell on the same area of this research extensively using a wider data and area of coverage

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