LIQUIDITY PROBLEM IN COMMERCIAL BANKS IN NIGERIA
WHAT IS LIQUIDITY
Liquidity has been defined by different authors and financial authorities in many ways. These are as follows: going by the definition given by the R.S. Seyers modern banking, fifth edition, he defined liquidity as “the word that the banker used to describe his ability to satisfy demands for each in exchange for depositors.
Bola Susuwa also defined it as “the cash with which banks assets would be converted into cash. The liquid assets include cash in the vaults, with the central bank and other governmental securities tat have not been used as collateral for loans. To satisfy depositors claim, as banks must be able to covert its assets into cash quickly. But that is not all. If the depositors claim to be fully satisfied, the banker’s assets must be converted into cash without loss.
When bankers said they aim of liquidity. They have generally included both these attributes. Treasury bills, and bill of exchange, which meet central bank requirement, are the most generally liquid earning assets, but not in London.
In London, the most liquid assets in order of liquidity are cash; the money at call is so far as it is converted by eligible paper deposited by the discount houses.
After that, comes Treasury bill and bill of exchange in order of nearness for maturity.
2.2 LIQUID RISKS
Liquid risks are the risks that funds are not available to meet deposit withdrawn. Loans draw during maturities, and other cash outflows. Banks liquidity is managed with the aim of meeting the following criteria:
- To meet borrowing requirements of the credit customers.
- To meet withdrawal requirement of the deposition upon demand.
- To be able to utilize the opportunities that might come their way in future (transactionary motives).
- Diversifying sources of funds in terms of types of instruments and maturities.
- Maintaining the statutory liquidity ratio, which results to the assets and liability sides of the balance sheet.
The assets Liagu-resides in:
- The ability to convert assets to cash and the self which can be sold to other banks or an open market including martable securities and certain loans: maturing loans and inter banks placement provide liquidity as they are rapid while the liability liquidity resides in the bank’s ability to:
Attract deposited and issue money market liabilities and negotiable or non-negotiable certificates e.g. deposits.
The asset liability should be regarded as coequal element in any liquidity management policy in terms of very short terms assets and liabilities, however, greater liquidity generally is available in the liability side of the balance sheet inevasible but additional liquidity can be generated through the banks access to the money market, through the issues of negotiable certificates of deposits, inter banks borrowing call money rediscount arrangement and the issue of commercial papers.
Ultimately, a bank with persistent liquidity problems must curtail its lending activities, as excessive lending is usually a major course of a shortage of liquidity. If a bank is unable to attract sufficient deposits, this will result in illiquidity.
2.3 LIQUIDITY VERSUS PROFITABILITY IN COMMERCIAL BANKING
At a micro level, the individual commercial banks are viewed as an economic unit whose goal is to maximize profit. Banks hold portfolio of assets and given the characteristics and distribution of their liabilities, they attempt to structure those in such a manner as to yield the greatest returns, subject to certain constraints. The assets held by bank may be divided into two broad classes; earning assets are the two groups of balance sheet items collect loans and investments.
Non-earning assets consists of fixed assets, the total reserves of the banks and non-interest earning deposits with the earning assets. (Loans and investments) while liquidity is provided partly by earning assets like short-term investment and partly by non-earning assets e.g. cash balance held in vault and at the central bank and cash reserves.
2.4 SIGNIFICANCE OF LIQUIDITY RATIO
It will be of great importance of investigate the rationale for using liquidity as an instrument of money control. The original purpose of liquidity ratio was to provide, commercial banks in some proportions to deposits into cash. In other words, the aim was designed to provide a primary line of defense for a bank in meeting withdrawals of depositors either by hand, in cash or cheque. This requirement was necessary in order to maintain the credibility of customers for inability to meet demands for cash would failure or at least loss of confidence in the banks.
This above objectives seems plausible because banks at all times strive to meet the customer’s depositor’s need in terms of withdrawal. This they do to maintain their valuable customers.
The most generally accepted purpose of liquidity ratio is that its use for regulating banks depositor is indirectly the volume of banks assets. As the liquidity ratio rises or falls, so do commercial bans, loans and investment fluctuate in the reserve directions. Consequently, the volume of economic activities would fluctuate.
The importance of the monetary authority to control the bank deposits stems from the ability of commercial bank create money through their issue of loans and overdraft to business men and other customers. These can be transacted on by using cheque and this instrument serves as money and the ramification serves as money and the commercial banks if unchecked could use as much as any amount cheque they desire.
In practice therefore, a judicious and prudent bank management of funds requires that a certain minimum level of cash or other liquid assets, easily convertible into cash be reserved. The amount of such reserves will be such that it can support a given volume of deposit in proportion to its reserves.
2.5 RATIONAL FOR LIQUIDITY RATIO REQUIREMENT
One might ask why most banks are required to maintain liquidity ratio? 0the just and perhaps the most important reason is that the deposits with the banks with which they (banks) transact, stands out to protect the interest of the public by making sure that their money is not misused or abused as was the words it was aimed at ensuring that commercial banks maintained 0a certain proportion of cash to deposits so as o ensure depositors convertibility of their deposits into cash (that is demand for their deposits) liquidity ratio therefore, is designed to produce a primary rise of defense for a bank in meeting withdrawals of deposit or either by hand-to-hand money, or by cheque. This requirement was thought necessary in order to maintain the creditability of customers for inability to meet demands for cash would mean failure of at least loss of confidence in the banks.
Therefore, by enforcing such an action, there aim was to make sure that the 0depositors demands for their money are met.
On the other hand, liquidity ratio is aimed at achieving accelerated economic growth would achieve such reducing their funds for banks lending.
Therefore, as bank liquidity ratio rises, or fails, so commercial bank loans and investment fluctuate but in a reserve order as well as the economic activity.
The ability of bank to create money has led to the need for the regulation o bank deposits. Their ability of creating money stems form the fact that they can issue cheque above the actual amount with them. This is feasible as a result of the law of large numbers.
Although, this is possible in practice there is need to keep a certain percentage of bank asset in liquid form. The amount of such liquid assets is such that it cannot only meet 0the volume of deposits but also be able enough to avoid itself with the fluctuations in the economy and be able to contribute towards achieving a desired economic goal.
2.6 FACTORS AFFECTING LIQUIDITY OF COMMERCIAL BANKS
There are many factors that affect the level of liquidity ratio. These include amongst others, the amount of the cash in the country as well as the average public demands for cash. If it occurs that there is a continuous inflow of revenue to the country like what was obtainable during the boom is: the liquidity of banks is likely to increase and vice versa.
If a commercial bank keeps liquid asset above the specified level, it is said to be operating with excess reserve. If on the other hand, the firm has excess reserve, that is, it is maintaining the specified level. It is said to be fully loaned up.
Another factor that could offset the liquidity of a bank is the objective of the bank. If a bank objective is profit maximizing, it is likely to be less liquid. It is generally known that actions designed to raise liquidity generally reduce earnings. While actions designed to increase earnings may have a reserve effect by reducing liquidity.
However, as illiquidity appears to be an unacceptable option, profit opportunities should be pursued with incurring undue exposure to liquidity risks. Banks face a section a here because the quicker an assets can be converted into cash the lower the rate of interest it earns. Assets that take longer time to turn into cash demands higher rate are charged for most liquid of bank earning assets. So a bank must strike 0a balance between adequate liquidity and its reducing effect on profit and high profitability with the consequent worsening of the liquidity position.
FACTORS AFFECTING LIQUIDITY OF COMMERCIAL BANKS
There are so many factors that affect the level of liquidity ratio. This includes amongst the amount of cash in the country as well as the average public demand for cash. If it occurs that the average is a continuous inflow of revenue to the country like what was obtainable during the oil boom era. The liquidity of bank is likely to increase and vice versa.
If commercial banks keep liquid assets above the specified level, it is said to be fully loaned up.
Another factor that could off set the liquidity of a bank is the objectives of the bank. If a bank objective is profit maximizing, it is likely to be less liquid. It is generally known that actions designed to raise liquidity generally reduce earnings. While actions designed to increase earnings may have a reserve effect by reducing liquidity.
However as illiquidity appear to be an unacceptable option, profit opportunities should be pursued without uncuring undue exposure to liquidity risks. Banks face a serious dilemma here because the quicker an asset can be converted into cash, the lower the rate of time to turn into cash commands higher rates of interest –and generally, the highest rates are charged for most illiquid of a bank earning assets. So, a bank must strike a balance between adequate liquidity and its reducing effect on profits and high profitability with the consequent worsening of the liquidity positions.
2.8 FEDERAL GOVERNMETN STEPS TOWARD SOLVING LIQUIDITY PROBLEMS IN COMMERCIAL BANKING
Liquidity problems in commercial banking have been serious problems to the federal government. In an effort to solve this problem, the federal government through the central bank introduced different policy measures. Amongst them are:
OPEN MARKET OPERATIONS
In condition of very high excess liquidity as Nigeria experienced particularly during the co-called oil boom between the period of 1973 and 1976. Large sales or securities would be required to unaligned seriously on commercial banks.
Liquidity rate also the authorities may be unwilling to undertake sales of such magnitude in view of their impact on security 0prices and government debt, and the authorities may bend up as not buyers even though they started as sellers. But this problem is not peculiar to developing countries. It is a common 0characteristics danger of open market operations, anywhere whether in developed or in developing countries.
Any central bank that undertakes sales of securities of such magnitude at any point in time will be faced with some problem.
Another measure is the use of special deposits to control the liquidity of commercial banks. Although, it was given the powers to use this weapon in 1968, the central bank has not exercised them except once in June, 1971. The occasion for the one use of the weapon on alarming is in bank liquidity as a result of the deposits by importers of the local currency counter part of the foreign currency value of their imports for which foreign exchange had not been allocated. By June 1971, such local currency deposits had run to and 400m and had swelled aggregate bank liquidity. To moderate inflationary pressure, the central bank of Nigeria on 10th of June 1972. Directed that banks whose level of short-term external liabilities was above N20 million should deposit the local currency counter part of the excess with it or before 30th June of that same year. Apart from this, the central bank has not called for special deposit of the much high rate of inflation in subsequent years.
Again, under section 2 of the central bank of Nigeria amendment decree 1963, the central bank was given the power to use another authoritative or quantitative instrument stabilization securities.
Subsequent 7 of the decree states for instance, that the bank may for purpose of maintaining monetary stability of the economy of Nigeria, issued a place, sell repurchases, amortize or redeem securities to be known as stabilization securities which shall constitute its obligation and the securities shall be used at such rate of interest and under such condition of maturity, amortization and redemption as the bank may be appropriate. The bank (CBN) is also empowered having issued the stabilization securities to place or sell them by allocation to any financial institutions. If any institution refuses to accept or buy the securities, the degree empowers the central bank of Nigeria to perform as follows:
- To prohibit the institution concerned from expending new loans and advances and from undertaking investment until full compliance with he directive has been obtained.
- To levy times, which shall be civic debt against the institution not exceeding fifty ponds (100) for the default or as the case may be, for every day during which the continuous.
As a result of the continuing high liquid in commercial banks in 1976, new instruments were introduced to put a stop to that effect. One is the cash reserve ratio. For the first time in history, cash commercial bank was required to maintain with the central bank expressed as a ratio of its total demands deposits plus time deposits on which it pay its depositors interest less than 21/4 percent per annum. The stipulated as reserve ranges from 2 – 12:5% and varies with the size of banks deposits liabilities.
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