EFFECT OF LIQUIDITY MANAGEMENT ON THE PERFORMANCE OF COMMERCIAL BANKS. (A CASE OF STANBIC BANK)

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ABSTRACT

This study was undertaken to assess the effect of liquidity management on the performance of commercial banks taking a case of Stanbic bank Uganda Limited. It was guided by the following objectives namely; to identify the different liquidity management practices in commercial banks in Uganda, to examine the different determinants of liquidity in commercial banks of Uganda, and to determine the effect of Liquidity Management on profitability of commercial banks in Uganda.

The study was guided by a cross sectional case study research design. The researcher used simple random sampling for banking/credit/loan officers and clients of Stanbic bank and purposive sampling for branch managers and heads of departments. The researcher selected 70 participants as the sample for the study.

The study found out that liquidity management practices at Stanbic bank limited include; storage of cash, supply or withdraws of liquidity consistent with desired level of reserve money from market, daily assessment of liquidity conditions, as well as daily analysis and detailed estimation of the size and timing of cash inflows and outflows. It also found out that; Stanbic bank regularly monitors the quality of its assets, and also continuously captures large maturity mismatches to enhance profitability potential, Stanbic bank; has a team that regularly monitors international financial trends, as well as closely monitoring liquidity in macroeconomic platform; Stanbic bank has a system that improves capital adequacy, governance and liquidity risk, the bank also enhances transparency of its operations of credit as well as ensuring that reserves of liquid assets are sufficient to withstand adverse liquidity shocks. The study also found out that liquidity; is a precondition for daily operation, it affects bank operation, may lead banks to miss on incentives given by suppliers of credit, service and goods; adoption of liquidity strategies increases ROA, liquidity management ensures successful operations, improves earnings and capital; distressed banks only access funds from market at high interest rates which reduces profitability and the ration of liquid assets to customer and short term funding is positively related to ROA.

From the findings, the following recommendation were therefore made; (i)There is a need to invest the excess of liquidity available at the banks; (ii) Commercial banks should adopt a general framework for liquidity management; (iii) Banks need to adopt of a scientific methods in detection of the strengths and weaknesses points of liquidity; (iv) Bank managers should identify and monitor key business drivers; (v) Bank officials should be trained in the areas of liquidity management; (v) Bank managers should be forward looking, and focus on operational efficiency of the banking industry; (vi) High quality liquidity assets buffer sufficient to hedge sudden liquidity outflows should be maintained; and (vii) Banks should adopt optimum liquidity model

for maximum return on investment, survival, stability, growth and development of banking system in Uganda.

DECLARATION ....................................................................................................... i

APPROVAL................................................................................................................ i

DEDICATION ....................................................................................................................................ii

ACKNOWLEDGEMENT ........................................................................................ iii

TABLE OF CONTENTS .......................................................................................... iv

LIST OF TABLES...................................................................................................... ix

LIST OF FIGURES .................................................................................................... x

ABSTRACT ............................................................................................................... xi

LIST OF ACRONYMS ..............................................................................................xii

CHAPTER ONE ......................................................................................................... 1

INTRODUCTION ...................................................................................................... 1

1.0 Introduction ....................................................................................................... 1

1.1 Background ....................................................................................................... 1

1.1.1 Historical perspective ..................................................................................... 1

1.1.2 Theoretical perspective ................................................................................... 2

1.1.2.1 Theory of corporate liquidity ....................................................................... 3

1.1.2.2 Liquidity Management Preference Theory ................................................... 4

1.1.2.3 Shiftability Theory of Liquidity Management ..................................................... 4

1.1.3 Conceptual perspective ...................................................................................... 5

1.1.4 Contextual perspective ....................................................................................... 6

1.2 Problem statement ................................................................................................. 7

1.3 Purpose of the study ............................................................................................... 8

1.4 Objectives of the study ........................................................................................... 8

1.5 Research questions ............................................................................................ 9

1.6 Scope of the study............................................................................................... 9

1.6.1 Geographical scope...................................................................................... 9

1.6.2 Subject scope................................................................................................ 9

1.6.3 Time scope ................................................................................................... 9

1.7 Significance of the study .................................................................................... 10

1.8 Conceptual framework ......................................................................................... 11

CHAPTER TWO .......................................................................................................... 13

LITERATURE REVIEW.............................................................................................. 13

2.0 Introduction ....................................................................................................... 13

2.1 Theoretical Review ............................................................................................ 13

2.1.1 Theory of corporate liquidity ....................................................................... 13

2.2.1.2 Liquidity Management Preference Theory ............................................... 14

2.1.3 Shiftability Theory ........................................................................................ 14

2.2 Liquidity management practices and performance of commercial banks........... 14

2.3 Determinants of Liquidity in Financial Institutions ......................................... 17

2.3.1 Asset Quality ................................................................................................ 17

2.3.2 Macroeconomic Factors ................................................................................ 18

2.3.3 Capital Structure .......................................................................................... 19

2.4 Liquidity Management and Profitability of Banks ........................................ 20

2.5 Conclusion....................................................................................................... 24

CHAPTER THREE ................................................................................ 26

METHODOLOGY ......................................................................................... 26

3.0 Introduction .......................................................................................................... 26

3.1 Research Design ...................................................................................... 26

3.2 Study Population............................................................................................ 26

3.3 Sample size and selection..............................................................................27

3.4 Data Sources .................................................................................................. 28

3.5 Data Collection Methods............................................................................... 28

3.5.1. Interview Method............................................................................. 28

3.5.2. Questionnaire Survey Method ........................................................ 28

3.6. Data Collection Instruments ........................................................................ 29

3.6.1. Interview Guide ................................................................................. 29

3.6.2. Self-administered Questionnaire........................................................ 29

3.7 Data Quality Control ......................................................................................... 30

3.8 Data Analysis ..................................................................................................... 32

3.11 Measurement of Variables ................................................................. 32

3.12 Research Ethical Considerations .............................................................. 32

CHAPTER FOUR ....................................................................................................... 34

PRESENTATION, INTERPRETATION AND DATA ANALYSIS ......................... 34

4.1 Introduction ....................................................................................................... 34

4.2. Response Rate .................................................................................................... 34

4.3 Demographic Characteristics of the Respondents .............................................. 35

4.3.1 Gender ......................................................................................................... 35

4.3.2 Marital Status ............................................................................................ 35

4.3.3 Age............................................................................................................... 36

4.3.4 Education................................................................................................. 37

4.3.5 Working Experience .................................................................................. 38

4.4 Liquidity Management Practices .................................................................... 38

4.5 Determinants of Liquidity in Financial Institutions ....................................... 42

4.5.1 Asset Quality ........................................................................................... 43

4.5.2 Macro-economic factors ..........................................................................44

4.5.3 Capital Structure ...................................................................................... 45

4.4 Effect of Liquidity Management on profitability of banks commercial banks in Uganda .. 46

CHAPTER FIVE ....................................................................................................... 50

SUMMARY, DISCUSSIONS, CONCLUSIONS AND RECOMMENDATIONS....... 50

5.0 Introductions ....................................................................................................... 50

5.1 Summary of the Study ........................................................................................ 50

5.1.1 Different liquidity management practices in commercial banks of Uganda........ 50

5.1.2 Determinants of Liquidity in Financial Institutions ....................................... 51

5.1.3 Effect of Liquidity Management on profitability of Stanbic Bank ................ 51

5.2 Discussion of findings ........................................................................................... 52

5.2.1 Different liquidity management practices in commercial banks ..................... 52

5.2.2 Determinants of Liquidity in Commercial Banks of Uganda .......................... 52

5.2.3 Effect of Liquidity Management on Profitability of Commercial Banks in Uganda .... 54

5.3 Conclusions ............................................................................................................ 55

5.3.1 Different Liquidity Management Practices in Commercial banks .................. 55

5.3.2 Determinants of Liquidity in Commercial Banks of Uganda ......................... 55

5.3.3 Effect of Liquidity Management on Profitability of Commercial Banks in Uganda .... 55

5.4 Recommendations .................................................................................................. 56

5.5. Limitations ............................................................................................................. 57

5.6 Recommendations for further Research ................................................................. 57

REFERENCES ............................................................................................................... 58

APPENDICES .............................................................................................................. 65

APPENDIX 1: QUESTIONNAIRE TO RESPONDENTS ................................ 65

APPENDIX 2: INTERVIEW GUIDE ................................................................. 71

APPENDIX 3: SAMPLE SIZE DETERMINATION ..........................................72

LIST OF TABLES

Table 1: Accessible population, Sample size and Sampling techniques ..................... 27

Table 2: Table of Cronbach Alpha coefficients on reliability ....................................... 31

Table 3: Response rate.................................................................................................... 34

Table 4: Gender of respondents ....................................................................................... 35

Table 5: Marital status ................................................................................................. 36

Table 6: Age of respondents .......................................................................................... 36

Table 7: Education levels of the respondents................................................................. 37

Table 8: Working experience ......................................................................................... 38

Table 9: Liquidity management practices ...................................................................... 39

Table 10: Determinants of liquidity in financial institutions .......................................... 42

Table 11: Effect of Liquidity Management on profitability of Stanbic Bank.................... 46

LIST OF FIGURES

Figure 1: Conceptual frame work of the Relationship between liquidity management and

performance of commercial banks. ................................................................................. 11

LIST OF ACRONYMS


BOU	Bank of Uganda
CVI	Content Validity Index
DV	Dependent Variable
EU	European Union
GDP	Gross Domestic Product
IV	Independent Variable
MDIs	Microfinance and Deposit taking Institutions
NSE	Nairobi Security Exchange
ROA	Return on Assets
SPSS	Statistical Package for Social Scientists

CHAPTER ONE

INTRODUCTION

1.0 Introduction

This study investigated the effect of liquidity management on the performance of commercial banks, a case of Stanbic Bank Uganda Limited. This chapter describes the background of the study in terms of historical perspective, theoretical, conceptual, and contextual perspectives. It also describes the statement of the problem, purpose of the study, research objectives, research questions, scope of the study and the significance of the study.

1.1 Background

1.1.1 Historical perspective

According to Davydenko (2011), the performance of the banking sector and other financial sectors, in the past years have been overall sound despite the global crisis, in part, to proactive supervision by the regulators who have heightened their supervisory activities to detect any immediate stress present in the system.

Uganda‟s banking sector has developed since 1906, when the National bank of India, which later became Grindlays bank, was established (Bategeka and Okumu, 2010). However, prior to independence in 1962, the banking sector in Uganda was dominated by foreign owned commercial banks (Beck and Hesse, 2006). In 1966, the Bank of Uganda became the central bank, controlling all currency issues and foreign exchange management (Mutibwa, 2013). With the establishment of Uganda commercial banks and Uganda Development Bank in 1972, stateowned banks dominated the banking sector, on top of East African Development Bank which was established in 1967 (Bategeka and Okumu, 2010).

The financial institutions in Uganda are supervised and regulated by the Bank of Uganda, according to Bank of Uganda statute 1993; with the following objectives: ensuring that, financial institutions maintain an adequate level of liquidity at all times, able to meet all known obligations and commitments and plans for unforeseen obligations and commitments; promote public confidence in financial institutions in Uganda through ensuring that they have adequate liquidity at all times; ensure that financial institutions manage their liquidity by means of clear and well written policies which take into account all aspects of proper liquidity management; and provide guidance on compilation of accurate and timely liquidity returns (Bank of Uganda Statute, 1993).

In July 1999, the Bank of Uganda issued a policy statement which classified financial institutions into four Tiers. Tier IV; financial institutions which are not regulated by bank of Uganda and are not authorized to take in deposits from the public but may offer collateral or non-collateral loans. Tier III; Microfinance and Deposit taking Institutions (MDIs). Tier II; Credit institutions; Tier I; Commercial banks. Commercial banks are authorized to hold current, savings and fixed deposit accounts for both retail and corporate in local and international currency. In addition, Commercial banks are authorized to transact the business of foreign exchange in all currencies. This study focuses on Commercial banks, specifically effects of liquidity management on performance of commercial banks in Uganda, considering a case of Stanbic Bank Uganda.

1.1.2 Theoretical perspective

The study was anchored on three theories, the Theory of Corporate Liquidity, Liquidity

Management Preference Theory and Shiftability Theory of Liquidity Management.

1.1.2.1 Theory of corporate liquidity

Alexiou and Sofoklis (2009) proposed a theory of corporate liquidity demand that is based on the assumption that choices regarding liquidity will depend on firms‟ access to capital markets and the importance of future investment to the firms. The model predicts that financially constrained firms will save a positive fraction of incremental cash flows, while unconstrained ones will not. The cost incurred in a cash shortage is higher for firms with a larger investment opportunity set due to the expected losses that result from giving up valuable investment opportunities. A liquid company takes advantage of available investments, cash discounts and lower interest charges on borrowings. Hence there is a relationship between cash holdings and investment opportunity and thus financial performance.

The difficulties experienced by some banks and other financial institutions during the financial crisis were due to lapses in basic principles of liquidity management. In response, as the foundation of its liquidity framework, the Committee in 2008 published Principles for Sound Liquidity Risk Management and Supervision (“Sound Principles”). Liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses (Banks, 2005). The liquidity of an asset depends on the underlying stress scenario, the volume to be monetized and the timeframe considered. Therefore, efficient and effective liquidity management is crucial if the survival and prosperity of firms is to be assured.

According to the Banking Act (2014) and CBK Prudential Guideline (2013), an institution shall maintain such minimum holding of liquid assets as the Central Bank may from time to time determine. Ugandan banks are required to maintain a statutory minimum of twenty per cent (20%) of all its deposit liabilities, matured and short term liabilities in liquid assets. Liquidity

Ratio is determined by net liquid assets and total short term liabilities.

1.1.2.2 Liquidity Management Preference Theory

This theory was put forward by John Maynard Keynes (2011). Liquidity preference refers to the amount of money the public is willing to hold given the interest rate. Keynes argued that there are three reasons for holding liquid assets. First, they act as ordinary transactions, second the act as a precaution against a rainy day, and third they are used for speculative purposes. Keynes showed that transaction deposits vary inversely with the rate of interest. The main argument in this theory is that at very low interest rate, an increase in the money supply does not encourage people investment but instead increases cash balances. The reason is that people expect the

interest rate to rise later.

1.1.2.3 Shiftability Theory of Liquidity Management

Shiftability theory, developed by Bhattacharyya (2011), states that the level of defensible financial institution liquidity management is having possession or investing in legal capital capable of shifting solely to other investments in obtaining liquid equipment. Loan for instance becomes secondary back up while secondary back up shifts to become primary back up. This means Shiftability theory suggests that financial institutions should give credit paid with notification before they apply for commercial paper pawn. According to this theory banks maintain liquidity if they hold assets that are marketable. During a liquidity crisis such assets are easily converted into cash. Thus this theory contends that shiftability, or marketability or transferability of bank assets is a basis for ensuring good liquidity management (Deger & Adem, 2011).

Supposing when there are no hard cash, financial institutions tend to sell pawn goods on loan aiming to obtain adequate cash. The friction happens because collateral which is illiquid turns into liquid. Besides this they also often sell marketable securities like super common stock. As a result, the shiftability theory is comprehended to give description and confidence of management of financial institutions until certain degree of removable asset possession in condition is needed to fulfill liquidity management (De-Young & Rice, 2004).

1.1.3 Conceptual perspective

Liquidity entails meeting obligations as they fall due and striking a balance between the current assets and current liabilities. Chacko (2014) refers to liquidity as the ability of a firm to meet its short term obligations. According to Mahavidyalaya et al (2010) the term liquidity refers to the capability of the bank to meet short term financial obligations by converting the short term assets into cash without suffering any loss. Garcia-Herrero et al. (2009) suggested that liquidity can be defined in three contexts; where they distinguish the asset, asset-equity, and cash aspects of financial liquidity. The financial liquidity of company‟s assets – is the ability to convert assets into cash in the shortest possible time, at the lowest possible costs and without losing their value. Berrios (2013) also stated that operating liquidity is the level of liquidity required to meet an institution‟s daily cash outflow commitments. Liquidity entails meeting obligations as they fall due and striking a balance between the current assets and current liabilities. According to Claeys, Vander and Vannet (2008), normally a high liquidity is considered to be a sign of financial strength, however, according to some authors such as Goddard, Molyneux and Wilson (2004), a high liquidity can be as undesirable as a low this is because the financial institutions might be holding the excess liquidity that could be used for investments to increase returns and income. According to Havrylchyk and Emilia (2006) observes that companies are strained when their level of liquidity is low and have negative working capital. This is because either inadequate liquidity or excess liquidity may be injurious to the smooth operations of the organization (Hoffmann, 2011).

Iannota, Nocera and Sironi (2007) measured firm performance by return on assets which is EBIT / average total assets, return on equity that is net profit / equity, change in market value of equity, change in market value of equity, adjusted for dividends and risk. Kasekende and Ating-Ego

(2010) used return on equity and profit margin for the measurement of firm performance.

1.1.4 Contextual perspective

According to Mutibwa (2013), Uganda's financial system is relatively well developed and sound. The major elements of a well-developed financial system have been put in place, including the creation of the first credit reference bureau, and credit has grown rapidly in recent years, but the financial sector has still been unable to reach its full potential in supporting the allocation of economic resources across the economy.

The indicators of poor liquidity management are a fall in asset prices, inadequate debt, low marketability of assets (Saunders & Cornett, 2005). As a result, many commercial banks in Uganda face the challenge of reduced profitability (Kasekende & Ating-Ego, 2003). Therefore, liquidity management is regarded as the life blood of the economy and in its absence financial markets cease to function efficiently profitability (Molefe and Muzindutsi, 2016). Persistent liquidity management constraints in the Ugandan economy have resulted in reduced public confidence in the banking sector as well as increased financial disintermediation (Mutiibwa, 2013).

Commercial banks in Uganda that have faced a number of liquidity management problems have reported poor financial performance (Mutibwa, 2013). Poor liquidity management affect earnings and capital. In extreme cases it leads to insolvency and bank failure (Alemayehu &

Ndung‟u, 2012). Distressed banks can only access funds from the market at high interest rate

(Alemayehu & Ndung‟u, 2012). This eventually causes a decline in the banks' earnings. Moreover, a bank's further borrowing to meet depositors' demand may place the bank's capital at stake (Alemayehu & Ndung‟u, 2012). According to Stanbic Bank Annual Report (2015), the bank has managed to put in place a number of measures to manage its liquidity in order to ensure normal operations, however, it has not been well analysed to establish its impact on performance as well as establishing the best liquidity management practices in relation to the profitability of the bank. Therefore the current study sought to establish how best the management of liquidity in commercial banks like Stanbic bank Uganda limited can be a key tool towards performance.

1.2 Problem statement

According to Mutibwa (2013), commercial banks play their mediation role by absorbing financial surpluses from their holders (depositors) and put them at the disposal of investors (borrowers) to be directed towards various investment channels. This investment activity carried out by the bank is hardly devoid of risks and problems, because the bank is seeking to maximize its expected profits on these investments, and this requires optimum utilization of the available resources, since the bank is exposed at any moment to meet the obligations of its clients and depositors who want to withdraw their savings, and so the bank should be ready to meet these demands at any time.

However, the problem arises when the Bank is not able to meet these demands, especially those unexpected ones, which may embarrass the bank with its clients and may lose their trust over the time, in light of the intensive competition in the banking sector resulting from the increasing number of local banks, as well as intensive competition from the foreign banks that work in the local banking market (Mutibwa, 2013).

Therefore, each commercial bank has to work to maximize its profits, and at the same time be able to meet the financial requirements of its depositors by holding a sufficient amount of liquidity, in order to achieve a balance between the profitability and liquidity. Banks should determine the optimal amount of cash that enable them in achieving balance between profitability and liquidity together, because each level of liquidity has a different effect on the levels of profitability, and the problem arises when the commercial banks try to maximize their profit at the expense of neglecting the liquidity effect, which may cause a technical and financial hardship with the consequent withdraw of deposits. The current study therefore seeks to determine the impact of liquidity management on performance commercial banks with special emphasis on how efficient liquidity management, liquidity indicators affect bank‟s performance as well as the limitations that may hinder the achievement of the required balance between liquidity and performance, and how to overcome these limitations, taking Stanbic Bank Uganda Limited as a case study

1.3 Purpose of the study

The study sought to determine the effect of liquidity management in commercial banks of

Uganda, taking Stanbic Bank Uganda Limited as a case study.

1.4 Objectives of the study

The study was guided by the following objectives;

1. To identify the different liquidity management practices in commercial banks in Uganda.

2. To examine the different determinants of liquidity in commercial banks of Uganda.

3. To determine the effect of Liquidity Management on profitability of commercial banks in

Uganda.

1.5 Research questions

The study was guided by the following research questions;

1. What are the different liquidity management practices in commercial banks in Uganda?

2. What are the different determinants of liquidity in commercial banks of Uganda?

3. What is the effect of Liquidity Management on profitability of banks commercial banks in Uganda?

1.6 Scope of the study

1.6.1 Geographical scope

The geographical scope of the study was selected branches of Stanbic bank Uganda limited.

These included; Stanbic Main Branch Kampala Road, Makerere University Branch, Freedom City Branch, Entebbe Branch and Mukono branch.

1.6.2 Subject scope

The subject scope of the study was limited to forms of liquidity management used by commercial banks in Uganda, types of liquidity indicators and how they affect performance of commercial banks as well as factors that hinder a balance between liquidity and performance of commercial banks in Uganda.

1.6.3 Time scope

The time scope was six months including data collection, analysis and writing of the final report.

The study utilized publications and research studies for a period of ten years from 2006 to 2016.

This period was preferred because it is within this period that the government focused its attention on the strengthening financial liquidity in commercial banks in order to ensure financial performance.

1.7 Significance of the study

The study will be of great importance to the following stakeholders;

 Financial institutions

The study findings will benefit management and staff of financial institutions who will gain understanding into how their institutions can effectively manage their liquidity by coming up with appropriate practices for optimal liquidity levels. This will guide decision making and trend analysis of liquidity and financial performance of banks.

 Researchers

The research will also contribute to the literature on liquidity and financial performance especially in emerging countries like Uganda. It is hoped that the findings will be valuable to the academicians, who may find useful research gaps that may stimulate interest in further research in future. The study will add to the existing body of knowledge on liquidity and how liquidity impacts on financial performance and recommendations made will be of

significance to those who may wish to carry out further studies in the area.

 Policy makers

The understanding of the liquidity and its impact on financial performance in financial institutions will help policy makers – governments and other stakeholders – to design targeted policies and programs that will actively stimulate the growth and sustainability of the financial institutions in the country, as well as help those policy makers to support, encourage, and promote the establishment of appropriate policies to guide the firms.

 Investors

The study will also enable the investors to know the kind of information to be disclosed by firms on the financial statements as pertains to liquidity and financial performance.

1.8 Conceptual framework

According to Creswell (2003) conceptual framework is a basic structure of a research consisting of a certain abstract ideas and concepts that a researcher wants to observe or analyze. This study seeks to establish the effect of liquidity management on the performance of commercial banks in Uganda, a case of Stanbic Bank Uganda Limited.

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