ABSTRACT

One of the major indicators of financial performance
is profitability .Every stakeholder in the banking sector is interested in
liquidity and performance (profitability) of the bank, the Shareholders are
interested in profitability of the bank because it determines their returns on
investment. Depositors are concerned with the liquidity position of  their  banks because it determines the ability of the
bank to response to their  withdrawal
needs, which are normally on demand or on a short notice as the case may be.
The tax authorities are interested in the profitability of the bank in order to
determine the appropriate tax obligation to the government.

In a bid to see how the interest of the various
stakeholders could be protected, the effects of liquidity on the loan portfolio
performance of Nigerian Banks was examined. This study found out whether
liquidity proxies (loans to deposit ratio and liquidity ratio) have significant
impact on the loan portfolio performance (Profitability) of Nigerian banks with
Lending spread as proxy for loan performance.

To achieve the objectives of this research, a
quantitative research method (secondary data) was adopted. Using purposive data
collection approach, the study carried out a time series, cross

sectional analysis on the 12 banks listed on the Nigerian
Stock Exchange over a period of 8 years from 2008 to 2015. The selection of the
banks was determined by data availability for the period and the data were
retrieved from the Annual financial reports of the 12 banks as obtained in the
Nigerian Stock Exchange (NSE) and the respective banks’ websites. Panel data
regression analysis from Stata statistical software was employed to analyse the
data.

The study concluded that there is significant negative
impact of both liquidity ratio and loan to deposit ratio on lending spread. That
means, profitability is significantly but negatively influenced by liquidity.   

Keywords: Liquidity,
Loan portfolio, Lending Spread, Profitability, Loans- to- deposit ratio   

CHAPTER
ONE

INTRODUCTION

1.1       Background to the Study

The
importance of liquidity and profitability of banks has received tremendous
attention in the corporate world in recent years. The management of corporate
liquidity is one of the most critical areas in determining whether a firm will
be profitable or not. Liquidity of a firm represents its ability to carry out
all its financial obligations without affecting the business operations. A
business cannot run smoothly without the presence of adequate working capital.
Therefore, the importance of liquidity makes it necessary for banks to maintain
a reasonable amount of their assets in the form of cash in order to meet their
short term obligations. According to Saleh, (2014), profit is the bottom line
or ultimate performance result showing the net effects of bank policies and
activities in a financial year.

Profitability
being a measure of loan performance also refers to excess of firm’s revenue
over her operational cost or measurement of the rate of return on investment.
Enhancement of profitability is one of the ultimate goals of every firm, and
generally, banks strive to strike a balance between profitability and liquidity
(Niresh, 2012).

The Basel
Committee on Banking Supervision (2008) defined liquidity as the ability of a
bank to fund increases in assets and meet obligations as they fall due, without
incurring unacceptable losses. Liquidity could be risky when a financial firm,
though solvent, either does not have enough 
financial resources to allow it to meet its obligations as they fall
due, or can obtain, such funds only at excessive cost (Vento & Laganga,
2009).

Liquidity
risk appears when there are differences between the size and maturity of assets
and liabilities on the balance sheet. There are
generally two types of liquidity risks which are funding liquidity risk and
market liquidity risk. Funding liquidity risk is the risk that the bank is not
able to respond effectively to current needs as well as future cash needs
without affecting its daily operations and financial condition. Market
liquidity risk is defined as the risk that a bank cannot easily offset or
eliminate a position without significantly affecting the market price (Ferrouhi
& Lehadiri, 2014).

Profitability
and liquidity as performance indicators are important to the major stakeholders
of any firm and banks in particular. The shareholders are interested in the
profitability of banks because it determines their returns on investment.
Depositors are concerned with the liquidity position of their banks because it
determines the ability to respond to their withdrawal needs, which are normally
on demand or on a short notice as the case maybe. The tax authorities are interested
in the profitability of the banks in order to determine the appropriate tax
obligation (Olagunji, Adeyanju & Olabode, 2011). This study examined the
effect of liquidity on the loan portfolio performance (profitability) of
Nigerian banks in other to contribute to the gaps in the previous studies as
stated below.

1.2       Statement of the Problem

In Nigeria and the competitive world, the
banking sector has emerged as a key player, contributing its best to create
employment, and improving the financial sector of the country. With the current
and growing trend in Nigeria economy, it has become a challenge for the sector
to create employment and contribute meaningfully to the economy due to
inability to earn maximum profitability. Therefore, it is necessary for banks
to take dynamic decisions to effectively manage their assets, particularly loan
portfolio in order to bring about the needed improvement in their
profitability.

Moreover, considering the public loss of
confidence as a result of distress which bedevilled the financial sector
especially banks in the recent past; and the intensity of competition in the
banking sector due to the emergence of new banks, every deposit money bank
should ensure that it operates profitably and at the same time meets the financial
demands of its depositors by maintaining adequate liquidity (Olagunji,
Adeyanju, & Olabode, 2011).

Deposit
money banks are often confronted with the problem of how to choose and identify
the optimum point or the level at which it can maintain its assets in order to
optimize the set objectives (Ajibike & Aremu,
2015). This
investigated the effect of liquidity (the proportion of the deposits that may
be demanded by the depositors at any particular time) on the profitability of
banks. It will investigated liquidity position of banks in Nigeria.

1.3       Objective
of the Study

The main
objective of the study is to examine how liquidity position of Nigerian banks
affects their financial performance. The specific objectives are to:

1. examine the liquidity position of 
   selected quoted banks in Nigeria and
2. estimate
   the effect of liquidity on Banks’ profitability in Nigeria

1.4  Research
Questions

1.      What is the liquidity position of the selected
Nigerian Banks?

2.      What is the effect of Liquidity on the
profitability of selected Nigerian Banks?

1.5       Hypothesis

A null hypothesis has been formulated for
this study which is:

H0:
There is no significant relationship between liquidity and bank profitability

1.6       Significance of the Study

This
study would be of immense value to investors, regulators, Managers, academia
and other relevant stakeholders. By relating liquidity to loan portfolio
performance using lending spread as proxy for profitability, the study would
provide future researchers with an alternative measurement area which has
little or no research within the Nigerian context. This study evaluated banks’
liquidity position and how it affects their profitability.

Various studies on liquidity and
bank’s profitability concentrated on macroeconomic factors like Inflation and
exchange rate, while a few concentrated on firm level. This study employed firm
level data to examine the impact of liquidity on bank loan portfolio
performance in Nigeria.

Furthermore, the reports from empirical studies on
the subject matter still remain inconclusive. For instance, Ajibike and Aremu
(2015) reported positive relationship between liquidity and profitability but,
Olanrewaju and Adeyemi (2015) reported no significant relationship, while
Eljelly, (2004) and Dahiyat, (2016) concluded
that there is negative relationship between liquidity and profitability. The
lack of consensus among literatures clearly shows that further study needs to
be carried out. Also, this study
differs from existing literatures that examined the relationship between
liquidity and profitability by the use of Lending spread as proxy for measuring
bank’s loan portfolio performance (profitability) whereas others used either
Return on Assets(ROA) or Return on Equity (ROE).

1.7       Scope
of the Study

The study covered 12 of the 22 deposit
money banks listed on the Nigerian stock exchange as at Dec. 2015 over a period
of 8 years from 2008 to 2015.

1.8       Operational
Definition of Terms

Liquidity:
This is the
ability of a bank to fund increases in assets and meet obligations as they fall
due, without incurring unacceptable losses.

Loan
Portfolio: This refers to total of all loans held by a bank or finance company on
any given day.

Profitability:
Profitability is ability of a bank to use its resources to generate revenues in
excess of its expenses.

Bank:
This is an establishment authorized by a government to accept deposits, pay
interest, clear cheques, make loans, act as an intermediary in financial
transactions and provide other financial services to its customers.

Loan:
An amount of money advanced
at interest by a bankto a borrower, usually on collateral
security, for a certain period of time.

Lending
Spread:  This refers
to the difference in borrowing and lending
rates of financial institutions (such as banks) in nominal terms. i.e
the difference between interest paid on deposit to customers and the interest
charged on loans and advances.

Deposit:
This refers to money placed in banking institutions for safekeeping.

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