i
LIQUIDITY MANAGEMENT AND BANK PROFITABILITY: A CASE OF LISTED BANKS ON THE GHANA STOCK EXCHANGE
BY
MBA AUGUSTINE SANDINO
A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF
THE REQUIREMENTS FOR THE AWARD OF MASTER DEGREE IN
DEVELOPMENT FINANCE, UNIVERSITY OF GHANA BUSINESS
SCHOOL.
AUGUST 2019
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CANDIDATES’ DECLARATION
I the undersigned do hereby declare that this dissertation is the result of my own
original research and that no part of it has been presented for another degree in any
university. However, all sources of borrowed materials have been duly
acknowledged.
NAME…………………………………. SIGN…………DATE…............
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SUPERVISOR’S DECLARATION
I declare that the participation of this dissertation was in accordance with the guiding
principle on supervision of dissertation laid down by the University of Ghana
NAME: ......................................DATE……………………SIGN………………
iv
DEDICATION
This work is dedicated first to God almighty, for giving me the knowledge from the
beginning to the end of my study. I also dedicate it to my family for their moral and
financial support and all those who made this study possible.
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ACKNOWLEDGEMENT
First of all, I thank God almighty for his protection, grace and sustenance over the
period. My gratitude again goes to Dr. Amin Karim, my supervisor who patiently
guided and made constructive comments and suggestions from which the I have
benefited greatly throughout this research.
My sincere appreciation goes to all who took time off their work to share their
knowledge and experience and provided me with relevant materials for the study,
My final thanks go to my family whose prayers, encouragements and unconditional
love saw me throughout my stay at the University of Ghana and above all to the
Universities’ Management, Lecturers, Staff, all workers, and friends for their
support.
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ABSTRACT
Profitability and maximizing shareholders wealth top the chat when it comes the
reasons why people or organisations engage in business. A bank like any other
business venture also has these same objectives in mind. The contentious issue
however, is finding a right balance between the profit maximization objective and
the right amount of liquidity to hold amidst macro-economic variables such as Gross
Domestic Growth rate (GDP), inflation, etc. Evidence from prior academic literature
indicates that banks that do not find the right balance would end up being bankrupt
or insolvent. This research therefore attempts to address this by exploring how the
level of liquidity impacts profitability, and also the effects of Micro-economic and
bank specific factors on profitability. This research covered all banks listed on the
Ghana Stock exchange between 2010 and 2017. The study employed liquidity and
profitability ratios. Using the fixed effect regression model, the researcher found out
that Asset size, Capital ratio and Market share had a significant relationship with
profitability of banks.
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LIST OF TABLES TABLE PAGE
4.1 Definition, Notation and expected results………………………….33
5.1 Descriptive Statistics……………………………………………….35
5.2 Estimating of equation using fixed effect………………………….44
LIST OF FIGURES FIGURE PAGE
5.1 Net loans to total Deposits Trend……………………………………37
5.2 Loans to Total Assets Trend…………………………………………38
5.3 Average Liquidity trend for the listed banks…………………………39
5.4 Return on Assets Trend……………………………………………....40
5.5 Return on Equity Trend………………………………………………41
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Table of Contents
CANDIDATES’ DECLARATION........................................................................ ii
SUPERVISOR’S DECLARATION .................................................................. iii
DEDICATION................................................................................................... iv
ACKNOWLEDGEMENT .................................................................................. v
ABSTRACT ...................................................................................................... vi
LIST OF TABLES............................................................................................ vii
LIST OF FIGURES .......................................................................................... vii
1.0 INTRODUCTION ............................................................................................ 1
1.1 BACKGROUND OF THE STUDY ................................................................. 1
1.2 PROBLEM STATEMENT .............................................................................. 3
1.3 PURPOSE OF THE STUDY ........................................................................... 5
1.4 RESEARCH OBJECTIVE ............................................................................... 5
1.4.1 General Objective ...................................................................................... 5
1.4.2 Specific Objectives .................................................................................... 5
1.5 RESEARCH QUESTIONS .............................................................................. 6
1.5.1 Research Questions.................................. Error! Bookmark not defined. 1.6 HYPOTHESIS OF THE STUDY .................................................................... 6
1.7 SIGNIFICANCE OF THE STUDY ................................................................. 6
1.8 SCOPE AND ORGANIZATION OF THE STUDY ....................................... 7
1.8.1 Scope of the Study ..................................................................................... 7
1.8.2 Organization of the Study .......................................................................... 7
CHAPTER 2 .............................................................................................................. 9
2.1 AN INSIGHT INTO THE BANKING INDUSTRY OF GHANA.................. 9
CHAPTER THREE ................................................................................................. 12
LITERATURE REVIEW ........................................................................................ 12
3.1 INTRODUCTION .......................................................................................... 12
3.2 THEORETICAL LITERATURE ................................................................... 12
3.2.1 EVOLUTION OF BANKING IN GHANA ............................................ 12
3.2.2 THE CONCEPT OF LIQUIDITY ........................................................... 16
3.2.3 THEORIES OF LIQUIDITY .................................................................. 17
3.2.4 PROFITABILITY CONCEPT IN BANKS ............................................ 19
3.2.5 THEORETICAL LITERATURE ............................................................ 19
3.3 EMPERICAL REVIEW ................................................................................. 20
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3.3.1 Empirical Literature. ................................................................................ 20
3.3.2Empirical Literature on the determinants on Bank Profitability .............. 23
3.3.3 Measurement of Liquidity and Bank Profitability ................................... 25
3.3.4 Empirical Literature on Liquidity and Bank Profitability ....................... 27
CHAPTER FOUR .................................................................................................... 29
METHODOLOGY .................................................................................................. 29
4.1 INTRODUCTION .......................................................................................... 29
4.2 RESEARCH DESIGN ................................................................................... 29
4.3TARGET POPULATION ............................................................................... 29
4.4 SAMPLE AND SAMPLING TECHNIQUE ................................................. 30
4.5 DATA COLLECTION ................................................................................... 30
4.6 DATA ANALYSIS ........................................................................................ 30
4.7 ANALYTICAL TECHNIQUE ...................................................................... 31
3.8 MODEL SPECIFICATION ........................................................................... 31
CHAPTER FIVE ..................................................................................................... 35
RESULTS AND DISCUSSION .............................................................................. 35
5.1 INTRODUCTION .......................................................................................... 35
5.2 DESCRIPTIVE STATISTICS ....................................................................... 35
5.2 TREND ANALYSIS OF LISTED BANKS .................................................. 37
5.2.1 LIQUIDITY TRENDS FOR THE LISTED BANKS ............................. 37
5.3 FITTING THE LINEAR REGRESSION ...................................................... 43
5.3.1 Fixed effect model results. ....................................................................... 43
5.4 Panel Model Regression ................................................................................. 43
CHAPTER SIX ........................................................................................................ 46
CONCLUSIONS AND RECOMMENDATIONS .................................................. 46
6.1 INTRODUCTION .......................................................................................... 46
6.2 SUMMARY ................................................................................................... 46
6.3 RECOMMENDATION ................................................................................. 47
6.4 LIMITATIONS .............................................................................................. 47
6.5 FURTHER STUDIES .................................................................................... 47
REFERENCE ........................................................................................................... 48
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CHAPTER ONE
INTRODUCTION TO THE STUDY
1.0 INTRODUCTION
The basis of the research is covered in this section. It gives an understanding into the
notion of liquidity and bank profitability. It sets the context to the research. The
section continued with the clarification of the issue declaration and postulated the
goals to be accomplished by the completion of the research. The importance of the
research, accompanied by the breadth and organisation, is presented in this chapter.
1.1 BACKGROUND OF THE STUDY
For an economy of any country to thrive, the role of banks cannot be overlooked
because they ensure that there is a balance in the financial system. This role has
continued in contemporary times through banking reforms to conform to the changes
in the economy (Konadu, 2009). Banks provide financial intermediation and other
financial services which are critical for economic growth and development, with the
expectation of earning profit from these activities. (Konadu 2009, cited in Fraser et
al 2001). The main objective of a bank like any other business is to maximize
shareholder wealth. Olagunju, Adeyanju & Olabode (2001), argued that “acceptable
financial intermediation requires the decisive attention of the bank management to
profitability and liquidity, which are two conflicting goals of banks. These objectives
are analogous in the sense that an attempt for a bank to attain higher profitability will
certainly erode its liquidity and solvency positions and vice versa”. Practically,
profitability and liquidity are effective indicators of corporate health and
performance. However, the “performance of these functions by banks opens them to
several risks; prominent among these is liquidity risk. Liquidity risk is basically the
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inability of a bank to meet its financial obligations to its customers as and when they
fall due. The liquidity of a commercial bank is its ability to fund all contractual
obligations as they fall due”. These may include lending and investment
commitments and deposit withdrawals and liability maturities, in the normal course
of business (Amengor, 2010). The Basel Committee was of the view that banks
liquidity risk exposure usually arises when the bank plays the fundamental role of
maturity transformation of short-term deposit into long-term that is the conversion of
short-term liquid liabilities to long term illiquid assets and also all financial
operations can affect the liquidity position of a bank. The Banking Act 2004 (Act
673) Section 31 urges banks to keep “10% of their deposits as primary reserves in an
account with Bank of Ghana”. The primary reserve, however, is used primarily to
settle inter-bank indebtedness, and also as insurance for depositors. This whole
procedure is termed as liquidity management. Liquidity management is very
important for every organization of which banks for that matter are not an exception
for paying current obligations on business and also effective liquidity management
helps ensure a bank's ability to meet cash flow obligation which is not known as they
are affected by other agent's behavior and by external events. Eljelly (2004) argues
that the “working capital approach to liquidity management has long been a
prominent technique used to plan and control liquidity. The working capital includes
all the items shown on a company's balance sheet as short-term or current assets while
networking capital excludes current liabilities”. This is an effective way to
understands an organisations ability to continue its activities. Many researchers
prefer “current and quick ratios” as a means of evaluating liquidity. This is because
it makes comparisons easier “the ultimate measure of the efficiency of liquidity
planning and control is the effect it has on profits and shareholders' value”. Thus, this
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study attempts to examine the bank profitability and how it is affected by liquidity
using listed banks on the Ghana stock exchange. The research reflects net profit
margin, return on equity, return on assets and net assets turn over ratios to establish
bank profitability trends for comparison.
Bank profitability is the ability of a bank to generate revenue over cost, to the bank's
capital base. The fundamental measures in the literature of bank profitability include
“return on assets (ROA), return on equity (ROE)”.
1.2 PROBLEM STATEMENT
The financial system in Ghana ranges from bank to non-bank financial institutions in
which the banking system dominates. The banking sector is crucial to the survival of
the economy as it make up for about “70% financial sector of Ghana as at 2008”.
Hence the survival of banks very essential as it contributes to economic development
and its failure has dire consequences for the nation. Basel Committee (1988) laid a
blue print for the effective management of both the risk of default and systematic
risks in “Basel 1 Accord” and centered on the management of “operational risk in the
Basel II Accord in 2004”, the risk of liquidity which most banks face seemed to have
been ignored. According to Landskroner & Paroush (2008), “thorough discussions
on major banking risks including credit risk, market risk and operations risk has taken
place places especially in the field of academia, while little attention has however
been paid to liquidity risk”. Shen et al. (2009) brought to our attention that an optimal
financial environment there should be hardly any issues related to the liquidity
positions of banks, research across the globe has indicated that this if far from the
truth, Crowe (2009) in his paper emphasize that “regulators and financial institutions
after the various economic and banking crisis across the globe confirming the feeling
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that liquidity risk has not been sufficiently covered by the prevailing risk
management practices”.
The indusry over the past years have engaged in strong competition for customer
deposits. Banks are selling their product through different means, examples include
advertisement in both electronic and print media, “jaw-dropping promotions and the
salesmen who sell to varied customers on daily basis just in their quest to maximize
customer deposit”. Jenkinson (2008) stated that “the fundamental traditional function
of financial intermediation surely exposes these commercial banks to liquidity risk
due to the inevitable maturity transformation mismatch and the inherent liquidity of
the banks' assets that is the extent to which an asset can be sold without incurring any
significant loss of value under any market condition and also easily”. The basic
responsibility of banks is financial intermediation and this responsibility if performed
well determines how profitable the bank would be.
However, the robust competition seems to be of no significant value to the Ghanaian
economic environment, Reports indicated that “access to credit has overtaken cost of
credit as the main challenge facing businesses in Ghana”. We know from previous
literature that the business of a bank is financial intermediation, and if that is the case
the following questions were posed after the Banking survey in 2014: “why are banks
in Ghana still very liquid when businesses need such funds? Are the banks relying
on some new sources of generating their income other than on the granting of loans?
Are Ghanaian banks vulnerable to liquidity risk depending on their sources of
funding and how much of it is lend out?”
Research conducted over the period across diverse continents and banks on liquidity
and performance have concluded on different status of the “relationship between
liquidity and profitability”. Others have also indicated that there is a positive
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relationship between these two variables, Eichengreen & Gibson (2001). Saleem &
Ur Rehman, (2011) also revealed “there is a significant impact of only liquid ratio
ROA while insignificant on ROE and ROI, the results also show that ROE is not
significantly affected by three ratios current ratio, quick ratio, and liquid ratio while
ROI is greatly affected by current ratios, quick ratios, and liquid ratio”. The findings
of these studies are limited according to the extent to which they can be generalized
across every period due to changes in the banks operating requirements. As a result,
this study also seeks to determine the effect of bank liquidity on bank profitability
using their operating periods of 2010 to 2017.
1.3 PURPOSE OF THE STUDY
The purpose of the study is determined the effect of bank liquidity on bank
profitability using the selected listed banks on the Ghana Stock Exchange with
operating periods of 2010 to 2017.
1.4 RESEARCH OBJECTIVE
1.4.1 General Objective
To examine effect liquidity on bank profitability of listed bank on the Ghana Stock Exchange.
1.4.2 Specific Objectives
1. To examine the “liquidity and profitability” trends of the listed banks in the
Ghana Stock Exchange in the study period.
2. To determine the extent to which banks profitability is affected by banks
liquidity.
3. To examine the effects of other micro-economic variables on bank
profitability.
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1.5 RESEARCH QUESTIONS
1. To what extent is banks profitability affected by banks liquidity?
2. What is the profitability trend among selected banks?
3. What is the liquidity trend among selected banks?
1.6 HYPOTHESIS OF THE STUDY
Hypothesis 1
Ho: There is no relationship between ROA and Net Loans-to-Total Deposit of listed
banks.
H1: There is a relationship between ROA and Net Loans-to-Total Deposit of listed
banks.
Hypothesis 2
Ho: There is a no relationship between ROA and Loans to Assets of listed banks
H1: There is a relationship between ROA and Loans to Assets of listed banks.
1.7 SIGNIFICANCE OF THE STUDY
The discoveries of this study will not only be beneficial to selected banks of the study
but will go help the industry in knowing the status of liquidity on the industry. The
study is also useful to other companies outside the industry in making investment
decisions as well as individual investors. The finding will also aid other stakeholders
on their lending and remittance decisions and finally adding to existing knowledge
as well as the body of academia, policy formulators, and the general business
environment.
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1.8 SCOPE AND ORGANIZATION OF THE STUDY
1.8.1 Scope of the Study
The study was centred around the listed banks on the stock exchange and how
managing their liquidity levels could enhance their profitability. It also looked at
industry variables as well as macro-economic factors as well that could also impact
profitability. Profitability was represented by Return on Assets whiles liquidity was
measured by Loans to total Deposits ratio.
1.8.2 Organization of the Study
The entirety of this research work was broken down into six sections. The first
Chapter gave an insight on why conducting this research is of upmost importance. In
other to get a better understanding it was further divided in subsections containing
the significance of the study, the objectives which would be fulfilled at the end of the
study, the critical questions that form part of the basis of this research and the
formulated hypothesis. An insight into the banking industry is captured in chapter
two. The literature review is captured in three chapter. Research over the years
conducted on this topic area were of either a theoretical or empirical nature, this
section seeks to examine both the theoretical and empirical literatures, also concepts
that surround this topic would be explained in this section. Chapter four would
explain how data which would be need to arrive at a conclusion for this research
would be collected, from which source (secondary or Primary), the size of sample
and the techniques for the sample size and the target population. The finding of this
study would be embodied in chapter five. Chapter six concludes the study where the
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researcher summarized the findings of the study and appropriate recommendations
are offered to industry stake holders based on the findings and conclusions drawn
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CHAPTER 2
2.1 AN INSIGHT INTO THE BANKING INDUSTRY OF GHANA
The industry has seen over the last couple of years a very fast growth. A survey
conducted in 2014 on the banking industry, indicated that the “financial sector is
well-capitalized; liquidity is fairly stable, profitability has improved and recording a
robust growth in asset”. Financial sector stability is a priority to the Central Bank and
over the years due to strong polices and sound management, the financial sector
reliability indicators shows an improvement. “Indeed, despite the banking system's
rapid growth led by expansion in deposit mobilization and credit though lower; the
system is becoming increasingly sound, due to determined regulation, significant
technological advances in the sector, and more prudent risk management by banks”.
Today the Ghanaian banking industry is fairly saturated comprising 23 universal
banks, 135 rural and community banks, and 58 non-banking financial institutions
including finance houses, savings, and loans, leasing, and mortgage firms. During
the year the regulator strengthened its supervision of these non-bank financial
institutions. This led to the closure of those institutions which did not meet the
regulatory requirement. The central bank (Bank of Ghana) regulates and oversees all
these banks. Banks in Ghana can offer all kinds of services because they take their
cue from the concept of universal banking. Universal banks currently were one’s
banks in the past that performed only one kind of service. The Bank of Ghana
regulatory and supervisory role is to enable sound, the “efficient banking system in
the interest of investors, depositors and other customers of these institutions and the
economy in general”. The regulatory and legal framework within which “banks, non-
bank financial institutions as well as forex bureau operate” in Ghana are the
following:
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• Bank of Ghana Act 2002, (Act 612)
• Banking Act, 2004 (Act 673)
• Non-Bank Financial Institutions Act, 2008 (Act 774)
• Companies Code Act 179, 1963
• Bank of Ghana Notices /Directives / Circulars / Regulations
Many changes reorganization have transpired resulting from inner and international
financial trends and crises. Recent developments in the banking sector was the
adoption of the “International Financial Reporting Standards (IFRS)” in line with
international standards by the Bank of Ghana as a way of “reducing systemic risk,
Collateral Registry and Credit Reference Bureaus where also set up to encourage
transparency and easy access of loans, establishment of the Financial Intelligence
Centre (FIC) to address money laundering and counter financing for terrorism, the
recapitalization of the banks all of which were fashioned to mitigate risk and stabilize
the banking system “(Bawumia et al., 2008). These changes are supported by closer
and more efficient supervision to guarantee economic stabilization and soundness. It
is therefore sensible to suppose that these changes have altered the operation and
efficiency of the banking industry.
“The effect of financial sector reform was to free the financial system from excessive
government regulation to foster a free market-based system, set prices right, improve
the regulatory framework, strengthen bank supervision, restructure distressed banks
and clean up non-performing loans on banks' balance sheet. Amidst the tight
regulation, exposure to varied banking risks, capitalization requirements; the banking
sector has immense developments which include an increase in the entry of new
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private banks into the market, expansion in branch network by both the existing and
new banks and the expanded use of branches by the existing and new banks etc”
In recent times one can hardly observe any difference between bank and non-bank
institutions. This is due to fierce competition between the two to attract customer
deposits. Let's take bank deposits for example; “banks compete now with other
liabilities of financial intermediaries, such as mutual funds”.
The annual comparative profitability analysis reported in the Ghana Banking Survey
(2015) exhibits that, “the Ghanaian banking industry has witnessed gradual increases
in profitability in the past years though the level of profitability varies amongst the
individual banks. For example, the industry’s profit before tax margin rose from
27.2% in 2010 to 30.6% in 2011 then to 37.3% in 2012 and then 45.3% in 2013.
Industry net interest margin (NIM) reduced from 9.3% to 8% in 2010 to 2011 it
increased in 2012 to 13.08% and in 2013 the industry experienced a 1.3% increase”.
From the above we can conclude that banks depend almost entirely on on deposits
from their clients. What this means for a bank is that for it to be liquid it has to
mobilize enough deposit.
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CHAPTER THREE
LITERATURE REVIEW
3.1 INTRODUCTION
Academic research in this topic are focused on theoretical or empirical evidences.
Some scholars combined both. This portion of the research seeks to analyse the ideas
and views shared by many writers and academics on this topic area. It also looks at
how far the banking industry of Ghana has evolved over the years.
3.2 THEORETICAL LITERATURE
3.2.1 EVOLUTION OF BANKING IN GHANA
The fundamental purpose of a banks is financial intermediation in that it accepts
deposits and gives out loans. The inception of banks begun in the then Gold Coast
under colonial purposely to provide funds for our British Rulers. The first bank to
approach the shores of Gold Coast was Standard chartered bank which was then “The
Bank of British West Africa” and started operating in Accra in 1896. The
lucrativeness of banking in Ghana was a signal to other foreign investors to start the
business of banking in Ghana. “The Colonial Bank, for example, began its activities
in 1918 and later merged with Somewhat Anglo-Egyptian Bank, the National Bank
of South Africa and Barclays Bank and ended up known as Barclays Bank”. Between
the periods of 1920 to 1950 there were only two banks in Ghana namely “Bank of
British West Africa and Barclays Banks”. Over the period of their operations, they
enjoyed so much monopoly in the economy such that the Government then thought
it wise to establish The Ghana Commercial Bank in 1953.
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In the wake of freedom from colonial rule in 1957, “the Bank of Ghana was set up to
assume responsibility for managing the nation's currency”. In 1974, a lot of banks
controlled by the state and “Development Financial Institutions (DFI)” had likewise
been established to improve the monetary supply by giving services, generally
undervalued by the commercial banks. “The National Investment Bank, Agricultural
Development Bank, Bank for Housing and Construction, Merchant Bank, the Social
Security Bank were examples of such institutions”.
“The changes experienced in the financial sector and the inception of the Banking
law in 1989 (PNDC Law 225) saw the operations of various locally incorporated
banks, including the Meridian (BIAO), The Trust Bank, CAL Merchant Bank, Allied
and Metropolitan Bank, and Ecobank”. Right after independence the banks mostly
lacked autonomy due to state influence. The era of 1960s and 1970s was
characterised by banks that lacked autonomy from government control. However,
Government in 1992 started to “denationalize a portion of the state claimed banks
and the liberalization of the financial sector which resulted in the entry of various
foreign banks into the Ghanaian economy as well as an expansion in the number of
domestic banks”.
Currently the minimum capital requirement for banks is GHS400 million, it was GHS
100 in 2013 and GHS 60million in 2007. The changes seen in the minimum capital
requirement over the years was as a result of the introduction of a new Banking Act
in 2004. “The new Act resulted in the inception of the Universal Banking Licence,
which enables banks to give different types of banking services”.
Mergers and acquisitions of certain banks additionally developed to a great extent by
the “increase in the minimum capital requirement with Access Bank and
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Intercontinental Bank, Ecobank and TTB Bank, and HFC Bank and Republic Bank
of Trinidad and Tobago” as examples.
Over the years in the banking history, many changes and adjustment can be noted
and the influx of Nigerian Banks into the economy is the most notable change. This
influx of Nigerian and other foreign banks has prompted a lot of challenges in the
industry especially when it comes to their ability to mobilize customer deposits and
their share in the market. “There are right now seven Nigerian banks working in
Ghana speaking to about 26% of the all-out number of banks in the nation. The high
influx of Nigerian Banks in Ghana has been occasioned by the ECOWAS convention
and the ideal financial condition in Ghana just as the generally high minimum capital
requirement for banks working in Nigeria”. It is anyway imperative to perceive that
the rivalry in the industry causally affects the degree of productivity and we have
seen some considerable degree of progress in administration conveyance and
effectiveness over the different banks in the nation. Once more, the challenge in the
financial business has additionally prompted technological advancements these
include; “Automated teller machines (ATMs), e-banking, phone banking (Mobile
money), SMS banking and so on, these technological developments have contributed
to a great extent to extending banking services in Ghana”.
The ongoing rivalry among banks has additionally forced the banks to re-evaluate
the way of managing informal sector. Banks now dedicate resources and personnel
to focus on the informal sector of the economy.
Some banks after the increase of the minimum capital requirement to GHS400million
could not afford it and stood a risk of insolvency, hence this resulted in a number of
mergers and acquisitions. The mergers and acquisitions made a bigger bank with
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immense capital base, which suggests the expansion of the Gross domestic product.
Expanding the base capital is likewise helpful as in banks are well insulated against
potential misfortunes from relating to the industry. Bigger banks are commonly
increasingly equipped for withstanding the shocks in the industry.
“Non-banking financial institutions comprise a stock exchange, insurance
companies, social security and national insurance trust, discount houses, building
societies, venture capital companies, mutual funds, and leasing companies”.
Banks given the fact that they are private or public entities that participate in the
provision of services with the expectation of making a return from these services,
then like any other profit motivated entity, maximizing shareholder wealth or
maximizing return to the business would be their main aim. The issue of how these
returns can be measured, or on what basis can it be determined that these returns are
acceptable to the owners becomes a question of great concern.
Fraser et al (2001) suggested that "shareholder value is measured by the market value
of a bank's stock and the amount of cash dividend paid". Currently, there are only “8
banks (out of 23 banks) listed on the stock exchange” and therefore stock prices
cannot be used as a measure of risk and return. For the unlisted banks, there is no
record of stocks values that can be relied on as an indicator of a company's financial
success or otherwise. Most financial analysts use a variety of assessment models to
appraise of companies in this instance.
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3.2.2 THE CONCEPT OF LIQUIDITY
Williamsonís (2008) in his research defined liquidity as “relates to the ability of an
economic agent to exchange his or her existing wealth for goods and services or other
assets”. According to Chamberlain (2008), “bank liquidity is the ability to meet
obligations when they fall due without incurring unacceptable losses in other words
this simply means the ability of banks to maintain enough cash to pay its maturing
and contractual obligations, these may include lending, investment commitments,
deposit withdrawals, and liability maturity, in the normal course of business”. Loans
granted to entrepreneurs constitute a small fraction of a bank’s resources. These
enable the entrepreneurs and bank clients to meet their additional need for capital.
(Diamond & Dybvig, 1983; Jekinson, 2008) also stated that “this transformation of
liquid liabilities that are deposited, into illiquid assets in the form of loan focusing on
their maturity mismatch exposes them to liquidity risk”. To bridge the mismatch of
asset and liability maturities, banks can ensure that they have enough assets which
can easily be exchanged for cash or its equivalent within a short period without a
significant loss in value on their balance sheet. “Banks should hold more liquid assets
in anticipation of future losses from securities write-downs”. Meeting obligations
such as withdrawals is very crucial as banks need a deposit to transform them into
loans. In light of all this, there is assets liability mismatch where the assets (loans)
cannot be quickly sold at a high price and customers demand their deposits within
the shortest possible time. Gorton & Winton (2003) argue that bank “liabilities
function as a medium of exchange. This basic function leads to ideals and models
concerning liquidity that are quite distinct and perhaps more natural than viewing
bank liabilities as allowing for just consumption smoothing”. This simply implies
that the more liquid a bank is the more business transaction that the bank can do versa
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vie more profit. However, it manifests a degree of inefficiency by management as it
limits banks' capability to meets its contractual obligations to its customers.
When a financial institution can’t tolerate a fall in liabilities or expand its assets, this
situation is defined funding liquidity risk and market liquidity risk according to
Decker (2000). He explained “funding liquidity risk as the risk that a bank will be
unable to meet its obligations as they fall due because of the inability to liquidate
assets or inadequate funding sources and market liquidity risk as the risk that a bank
cannot easily unwind or offset specific exposures without significantly lowering
market prices because of inadequate market depth or market disruptions”. Liquidity
management simply means controlling the amount of liquid assets a bank holds with
interfering with its ability to generate profits. Funding and market liquidity risk were
further explained in a research work by Gomes & Khan (2011). They indicated
“funding liquidity risk as the inability of a firm to generate funds by deploying assets
held on its balance sheet to meet financial obligations on short notice. The liquidity
position of a given bank is determined primarily by its holdings of cash and other
readily available marketable assets, as well as by its funding structure and the amount
and type of contingent liabilities that may come due over a specified horizon”.
3.2.3 THEORIES OF LIQUIDITY
Shiftability Theory
Toby (2006) in his work referred to Moulton H.G one of the originators of this theory,
which was propounded in the USA in 1918. Shiftability concept has clarified that a
bank's liquidity relies on its capacity to transfer its short-term asset to another at a
timely cost without making significant loss in the circumstance of a bank run.
Moulton specified that "liquidity is tantamount to shift ability, hence the bank's
ability to shift or sell its assets to potential buyers such as lenders or investors for
18
cash”. Shiftability theory readdresses banker and the regulatory authorities’ attention
to move from “loans to investments” as an avenue for bank resources.
Anticipated Income Theory
Herbert V. Prochnow designed this theory. It stipulated that before a financial
institution offer credit facilities, they should match it with an expected income.
Estimating future earnings should be made. In other words, proper and thorough
evaluation of a person's repayment ability whether he has a regular or high source of
income should be conducted. “Bank's liquidity can be managed by proper structuring
and phrasing of loan commitments made by the customers of the bank”. With this,
the liquidity of the banks can better structure customer loan repayment ability. Nzotta
(1997), stated that “the theory focuses on the earning capabilities and the
creditworthiness of a borrower as the overall guarantee for ensuring adequate
liquidity”. However, there is no clue about the future income of the borrower if
whether they will be willing or alive to pay what they owe.
Liability Management Theory
Developed in the 1960s, it is of the view that “banks can meet their liquidity
requirement by bidding in the market for additional funds to meet loan demand and
deposit withdrawal”. It further states that, an individual bank can create liabilities for
itself like borrowing from the central bank, borrowing from other commercial banks
and rising capital funds thorough issuing of shares and utilizing retained earnings.
However, as most banks face a shortage, banks tend to compete with each other for
funds available which in turn make funds costlier.
19
3.2.4 PROFITABILITY CONCEPT IN BANKS
Banks just like any other ordinary business venture strive is to make a profit for the
stability and growth of its organization and also to make its shareholders happy.
Financial institutions serve as a back bone for every economy, hence for an economy
to grow and be stable, the assessment and management of those financial institutions
must be well maintained. Aburime (2008) said, “profit means the difference between
the revenue generated from the normal course of business and the full opportunity
cost of the factor used in the production of that output”. Careful management of
bank’s operation leads to profit maximization.
Banks should opt for their survival by optimizing profit. Anayanwaokoro (1996) was
of the view that profits pivotal to bank in attracting customers as it means they would
be gaining higher interest on their deposit.
3.2.5 THEORETICAL LITERATURE
The Structure-Conduct-Performance (SCP) Model
This model explains various factors that determine bank profitability. Baye (2010),
explained that the “structure of an industry refers to factors such as concentration,
technology, and market conditions. Conduct is how individual firms behave in a
certain market; it involves advertising decisions, pricing decisions (such as
commission, interest rate, and fees), and decisions to invest in research and
development, among other factors”. Performance in this instance is the profit.
Capital Asset Pricing Model (CAPM)
It explains how risk and expected return are related. The varied risk associated with
the unique intermediation role played by banks cannot be overlooked in the pricing
20
of both their borrowing and lending rates and thus the expected returns on any
business they partake in. According to Brealey & Myers (2003), the capital asset
pricing model (CAPM) described “the risk and the expected return of an investment
or stock as how much investor expect from a given investment based on the risk in
the market”. High market risk would compel investors to expect to be compensated
highly for the high risk and vice versa. This model's fundamental concept and
significance in this research is focused on the reality that CAPM considers £the entire
investment as a function of market risk and diversifiable risk”. The market risk is due
to factors affecting the entire market, such as government policies, fiscal changes and
the political climate, which cannot therefore be prevented through diversification.
Diversification can thus avoid the unsystematic risk that a particular firm is exposed
to, such as industrial relations, leadership performance or a fresh competitor in the
sector. Though the model describes between expected return on investments and
risks, firms in the market can take a cue from it. Once equilibrium exist in the market,
Investors should only be compensated for market risk and not risk that can be
diversified.
Its drawback however is that it does not reflect actual market conditions and takes a
narrow view on the risk-return relationship.
3.3 EMPERICAL REVIEW
3.3.1 Empirical Literature.
Though Liquidity positions and its accompanied challenges are always considered
when the issue of bank profitability is raised, only a few writers have gone further to
study and consider the various determinants in the normal operations of a bank.
Works conducted by these few researchers show varied elements with regards to the
21
subject matter in different banking environment grouped into macro-economic
factors and bank-specific.
Shen et al. (2009) applied “panel data instrumental variables regression, using two-
stage least squares (2SLS) estimators” to estimate performance in relation to
liquidity. The study investigated “causes of liquidity risk using an unbalanced panel
dataset of 12 commercial banks from throughout 1994-2006”. They found that
liquidity risk is a significant determinant of bank performance, other elements that
could affect performance included size, amounts of liquid assets, and also dependent
on outside funding sources, regulatory and micro-economic factors.
Rauch et al. (2010) evaluated the elements of liquidity among banks. They sampled
457 banks owned by the government of Germany between the years of 1997-2006.
The research indicated the adverse effect on using interest rates to channel liquidity
and its adverse effects also on microeconomic variables such as narrow monetary
policy. The unemployment rate linked to the supply for credit used as a proxy for the
economy's overall safety showed adverse liquidity impact and therefore beneficial
effects on the liquidity risk. Hence, profitability variables and bank-size assessed by
an overall number of clients have no influence on the establishment of liquidity and
only macro-economic variables have a powerful link with liquidity risk.
Lucchetta (2007) stated however that “higher interest rates deter banks from taking
considerable risk and affects their liquidity choices”. It was therefore determined that
across nations in the European region, the interest rates among the various banks had
positive effects pertaining to how much liquidity banks retained and their choice to
lend to a bank within the industry. The predominant factors which predisposed the
choices of a bank to offer loans to another bank in the market was the liquidity price
22
which was contingent on the “risk-free interest rate” and the liquidity needs in the
market. The outcomes of the study showed a “negative relationship between the
interest rate” and a banks liquidity decision.
Aspachs et al. (2005) in a bid to ascertain macroeconomic variables as well as other
variables that were peculiar to only banks and could affect their profitability. The
study sample was made up of 57 banks within the United Kingdom between 1985 to
2003. The following conclusions were drawn: banks with the knowledge that they
can be cushioned by the Central Bank in times of financial difficulties should be one
of the motives to keep their liquidity levels low. This reason they further stated had
a “positive relationship with liquidity risk”. Furthermore, profitability which has
always been the oldest motive for conducting business and also quantifies the
opportunity cost for the desire to be liquid had a significant positive “connection with
liquidity risk. Lastly, bank size did not have a linear relationship with liquidity risk
but GDP growth “on the other hand had a significant positive relationship with
liquidity risk”.
Still, on liquidity ratio, Bunda & Desquilbet (2008) using a “panel regression model”,
they examined the factors that could result to higher risk of liquidity for a bank. The
research indicated that “the size of a bank had a positive effect on liquidity risk,
capital adequacy on the other hand had a adverse relation with liquidity risk”.
A study was conducted on liquidity shock and how it was managed during the
financial crisis period. Cornet et al. (2011) sampled quarterly data of all US
commercial banks. This was done by estimating separate regression functions for
both small and large banks with dependent variables such as the “share of illiquid
assets such as loans, leases, asset-backed securities among others on total assets, the
23
proportion of core deposits in total assets, the bank adequacy ratio, the ratio of unused
commitments to commitments plus assets”. The results were different according to
the size of the banks since small banks were more inclined to a stable source of
funding like deposits from customers relative to larger banks. It was further revealed
that larger banks have higher proportions of their total assets as illiquid assets as
compared to smaller banks, making them more “exposed to liquidity risk than small
banks across four dimensions including more undrawn commitments, less capital,
less reliance on core deposits and lower liquidity of balance sheet assets”.
3.3.2Empirical Literature on the determinants on Bank Profitability
In most academic research “return on assets (ROA), the return on equity (ROE) and
net interest margin (NIM) is usually expressed as a function of both internal external
measures of profitability such as Operating efficiency, capital adequacy, liquidity
and external determinants such as money supply, and banking industry
concentration”. Return on Asset simply tells us if an organisation is making the
optimum use of its resources to generate adequate profits. The downside of Return
on Asset is that it ignores items not on the balance sheet. Despite this drawback, it is
still suggested that Return on Assets is a reliable measure of profitability. Whiles the
Return on Equity measures how the organisation is able to generate profits on its
equity. The downside of this measure is that banks with “high financial leverage tend
to generate a higher ratio. Banks with high financial leverage may be associated with
a higher degree of risk although these banks may register high ROE”.
Mpesum (2010) researched on Cal Bank Ghana Ltd. and the factors that influenced
profitability of the bank. Results suggest that industry Size was a the most important
factor with regards to banks profitability. He observed an “inverse relationship
24
between size and profitability”, he therefore concluded that for a bank to be profitable
they need to be mindful to their size as well as the bureaucratic issues associated with
it. The gap in this research was that one bank was not representative of the whole
banking industry.
The wider strategy taken by Flamini el al (2009) took into account different
organization. In Sub-Saharan Africa, A sample of 389 companies existing from 1998
to 2006 in 41 nations was used to analyse the results. The findings indicate that, in
addition to loan uncertainty, greater yields on investments are linked to greater bank
size, diversification of operation and personal property. The yields on banks are
influenced by macroeconomic factors which indicate the credit expansion is driven
by macroeconomic policies that encourage small inflation and stable production
development. The findings also show that profitability persists moderately. Thus, the
paper gives throws weight to the idea of” higher capital requirements in the region to
ensure financial stability”.
Aburime (2008) conducted a study which tried to define economically the major
macroeconomic determinants of Nigerian bank profitability. The macroeconomic
indicators for Nigeria's real interest rates, inflation, fiscal, exchange rate schemes,
growth of the finance industry, inventory market growth, economic framework and
corporate tax policies were integrated into the same era using a panel data package
consisting of 1255 findings made by 154 banks during the 1980-2006 term. The
results revealed that “real interest rates, rates of inflation and monetary policy which
influences through liquidity ratio were positive and significant concerning bank
profitability in Nigeria. Again, partial or outright liberalization of the forex market
had a significantly negative impact on bank profitability implying that banks
significantly profited more during the fixed exchange rate regime in Nigeria. It was
25
further revealed that banking sector development, stock market development, and
financial structure did not have any significant influence on bank profitability in
Nigeria while the empirical relationship between corporate tax policy and bank
profitability was inconclusive”.
Vong et al., (2009) studied the “effect of bank characteristics as well as
macroeconomic and financial structure variables on the performance of the Macao
banking industry”. It was demonstrated that a strong capital position had a significant
impact on its profitability. This result is in line with that of Al-Shubiri (2010), Li
(2000) & Sufian (2009). Finally, inflation rate was the only macro-economic factor
to have a “significant relationship with profitability”.
Li (2000) in his research looked at factors peculiar to the banking industry and factors
emanating from the macro-economy as well that could have an effect on the
profitability of the baking sector in the United Kingdom between 1999-2006. It
aimed at showing how adequate banks were at managing risk. The outcome how ever
showed a significant negative association between profitability of banks and the
provision for loan loss. This result supported the findings of Sufian (2009). Finally,
he detected that factors affecting the macro-economy such as “inflation, interest rate,
and GDP growth had an effect on performance” but its effect was rather insignificant,
contrary to discoveries made by Vong et al, (2009) who demonstrated that inflation
had a significant impact on bank profitability.
3.3.3 Measurement of Liquidity and Bank Profitability
According to Ioan & Dragos (2006), “the management of liquidity risk presents two
main perspectives both of which affect a bank's profitability. It indicated that an
inadequate level of liquidity may lead to the need to attract additional sources of
26
funding associated with higher costs that will result in the reduction of the
profitability of the bank and ultimately lead to insolvency. On the other hand,
excessive liquidity may lead to a fall in net interest margins and consequently, poor
financial performance”.
Keeping appropriate levels of liquidity is manifested in a bank's ability to obtain with
urgency the needed funds at a reasonable cost as and when necessary. According to
Arif & Anees (2012) “banks borrowing to meet depositors' demand may place the
bank's capital in danger leading to rising in the debt-equity ratio, affecting the bank's
effort to maintain an optimal capital structure”.
Diamond & Rajan (2001) asserted that sometimes banks refuse to lend to potential
entrepreneur; if liquidity needs rise substantially; representing an opportunity loss for
the bank. They emphasized that a mismatch in depositors demand and production of
resources forces a bank to generate the resources at a higher cost and at rare situations
when a bank is unable to meet the requirements of demand deposits, there could be
a bank run.
However, Poorman & Blake (2005) cautioned that adopting only liquidity ratios as a
measure to liquidity risk would not be the solution to the liquidity risk menace. This
reason stemmed from the fact that a large regional bank, Southeast Bank, used over
30 liquidity ratios for liquidity measurement but eventually failed due to liquidity
risk. It is therefore imperative that beyond mere liquidity ratios, banks develop new
forms of measuring liquidity risk. While the Basel Committee on Banking
Supervision (2000) proposed the maturity laddering method for measuring liquidity
risk; Saunders & Cornett (2006) “gave a strong indication that banks could use
sources and uses of liquidity, peer group ratio comparisons, liquidity index, financing
27
gap, and the financing requirement, and liquidity planning to measure their liquidity
exposure”.
3.3.4 Empirical Literature on Liquidity and Bank Profitability
Scholars in the past have mostly measured liquidity using ratios that express how
liquidity is measured and have all not arrived at the same conclusion concerning
banks profitability. “Most of the widely used measures of liquidity are the ratio of
liquid assets to total assets, the ratio of loans to total assets, the ratio of liquid assets
to total deposits, the ratio of liquid assets to the customer and short-term funding, the
ratio of net loans to the customer and short to term funding”.
Kosmidou et al. (2005) also found that “the ratio of liquid assets to total deposits
that is from customer and short-term funding had a positive effect on the return on
assets (ROA) but a negative effect on net interest margins”.
Another popularly used ratio is “liquid assets to total assets”, this provides an insight
into the bank’s liquidity shock absorption capacity. As a rule of thumb, “the higher
the proportion of liquid assets to total assets, the higher the capacity of a bank to soak
up a probable liquidity shock, given that market liquidity is the same for all banks in
the sample.” Notwithstanding, a higher value of this ratio may be also taken as
inefficiency, since holding many liquid assets on the balance sheet results in lower
net interest margins hence the need to optimize liquidity and profitability and thus
reduce the opportunity cost of the bank”.
Other studies also relied on the ratio of “net loans to the customer (deposits) and
short-term funding has also been used significantly as a measure of liquidity risk.
Kosmidou (2008) indicated that the ratio of net loans to the customer and short-term
funding is negatively related to return on assets (ROA)”.
28
The “ratio of loans to total assets is used as a measure between liquidity risk and bank
profitability. This liquidity ratio measures the proportion of total assets made up of
net loans, thus a relative measure of illiquidity of a bank's total assets. This means
that the higher this ratio, the less liquid the bank is and the higher the vulnerability
to bank liquidity risk”.
29
CHAPTER FOUR
METHODOLOGY
4.1 INTRODUCTION
The methodology explains the approaches used in the study. The philosophical stance
that this study took was the Positivist Approach which entails using existing theories
to test the formulated hypothesis of the work. The chapter includes: the research
design of the study, the population and sampling technique. It also involves the data
source for the study and clarification on the various variables of the study as well as
how the data was analysed using financial ratios, and other statistical tools.
4.2 RESEARCH DESIGN
The study adopts the longitudinal time dimension, specifically the panel study type.
Neuman, (2007) describes panel study as a “powerful type of longitudinal research
in which the researchers observe exactly the same people, group, or organization
across multiple time points”. In this study the researcher used the banks listed on the
stock exchange. The researchers used purposive sampling technique in this study.
The quantitative analytical technique was used to achieve the objectives of the study
using statistical tools such as descriptive statistics and inferential statistics.
4.3 TARGET POPULATION
The target population that met the criteria for this study were the eight banks listed
on the Ghana stock exchange.
30
4.4 SAMPLE AND SAMPLING TECHNIQUE
Saunders, Lewis & Thornhill (2007) stated that, “the size of the sample and the way
in which it is selected will definitely have implication for the confidence you can
have in your data and the extent to which you can generalize”. Neuman (2006) also
asserted that, the ultimate aim of conducting sampling in a research, is to obtain
smaller units from a large population, so that an adequate generalization can be made
from the smaller group. With reference to this, all the listed banks on the Ghana
Stock Exchange were chosen using the time period of Seven (7) years out the
operating period of the banks, that is, from 2010 to 2017. The study considered non-
probability sampling techniques mainly the purposive sampling technique. This
technique was used to select the listed commercial banks and the number of years.
4.5 DATA COLLECTION
Academic research conducted usually rely on either primary or secondary data or a
combination of both. For the purpose of this research, data was mainly from
secondary sources. The researcher collected only audited financial statements from
the GSE website. Also, articles and scholarly journals were used too.
4.6 DATA ANALYSIS
Ratio analysis was adopted to gather the necessary information to be able to evaluate
the financial position and performance of the banks in terms of its ability to meet its
obligations as and when they fall due and profitability. The most efficient option to
summarize large quantities of financial data and make a qualitative judgment about
a firm’s financial performance is through the use of ratios, thus ratios reflecting a
quantitative relationship help form a qualitative judgement. The study focused on
“Return on Assets as the measures of bank’s performance whereas, the liquidity
31
ratios comprised of net loans to total deposit ratio and loans to total assets ratio”. The
rationale behind this set of variables was influenced by previous studios on financial
appraisal and ratio for assessing performance (Konadu, 2009).
4.7 ANALYTICAL TECHNIQUE
The researchers used Trend Analysis of ratios because in financial analysis direction
of change is very important (Konadu, 2009). Because this technique reflects the
direction of change in terms of financial performance being improved, deteriorated
or it has remained constant over time. They also used Linear Regression to be able
to determine the effect of liquidity on profitability. The researcher performed the
analysis using various statistical packages such as the Microsoft Excel.
4.8 MODEL SPECIFICATION
This thesis used panel model to analyse the collected data. For this study, fixed effect
model is selected. It is one of panel models which “control for unobserved
heterogeneity among cross sectional units”. The following equation indicates the
general model of the study.
𝜋𝑖𝑡 = 𝐶 + ∑ 𝛽𝑚𝑋𝑖𝑡𝑚 + ∑ 𝛽𝑚𝑋𝑖𝑡
𝑘 + 𝜀𝑖𝑡……………….( 1)𝑘=1𝑚=1
Type equation here.
Where:
𝜋𝑖𝑡 is the dependent variable and represent profitability of selected banks measured
by ROA, for bank i at time t.
32
C is the constant term.
∑ 𝛽𝑚𝑋𝑖𝑡𝑚
𝑚=1
= 𝑎 𝑣𝑒𝑐𝑡𝑜𝑟 𝑜𝑓 𝑚𝑡ℎ 𝑏𝑎𝑛𝑘 𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠
∑ 𝛽𝑘𝑋𝑖𝑡𝑘
𝑘=1
= 𝑖𝑠 𝑡ℎ𝑒 𝑣𝑒𝑐𝑡𝑜𝑟 𝑓𝑜𝑟 𝑘𝑡ℎ 𝑒𝑥𝑡𝑒𝑟𝑛𝑎𝑙 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒𝑠
Ɛit = the error term
Dependent Variable
Prior studies on the measures of bank profitability all point toward Return on assets
being the best measure, hence it is instrumental in comparing the operating
performance of banks.
Bank Specific Variables (Internal Factors)
Capital: capital ratio is “measured by total equity over total asset, reveals capital
adequacy and should capture the general safety and soundness of the financial
institution”. Prior research works indicated that capital and bank profitability positive
correlated (Anwar et al., 2011; Berger, 1995; Bashir, 2003).
Assets Size: For the purpose of this study, asset size is represented by “logarithm of
total assets (LOGTA)”. It is expected to be positively related. This might not be true
for banks because of the red tapes that may be associated with an increase in size
Loans: (Abreu & Mendes 2000; Bashir, 2003) stated that one of the common sources
through which banks generate income is by granting of loans to its customers. The
ratio is captured by dividing total loans to total assets.
33
Liquidity: liquidity ratio measured by net loans to total deposits. It is generally used
as a liquidity measure to examine how much loans a bank has given out to its
customers and how its customers deposited. “A positive and significant link between
bank liquidity and profitability” is expected
Macroeconomic and Industry Structure Variables (External Factors)
GDP Growth Rate: GDP growth rate essentially talks about how fast the economy
is growing and it is usually measured annually. It is expected that when an economy
is booming the banks should be more profitable. “Economic growth can enhance
bank’s profitability by increasing the demand for financial transactions, i.e., the
household and business demand for loans”.
Inflation Rate: This is generally defined as the “general increase in the price of
goods and service in an economy over a period of time”. The various studies
conducted regarding the possible effect of inflation on profitability have produced a
wide variety of results.
Market Share. This explains the proportion of the industry is controlled by a
particular bank. The research expects a positive relationship with profitability.
34
Table 4.1 Definitions, Notation and Expected Effect of the Explanatory Variables
VARIABLE MEASURE NOTION
EXPECTED SIGN
DEPENDENT VARIABLE
Return on Assets Net income after tax/total assets
ROA
INDEPENDENT VARIABLES (BANK SPECIFIC)
Capital Total equity/total assets
CAR Positive
Asset Size Natural logarithm of total assets
LOGTA
Positive
Loans Total loans /Total assets
LTA Positive
Liquidity Net loans / Total Deposits
LTD Positive
EXTERNAL VARIABLES
Inflation Rate Annual inflation rate INF Positive GDP growth rate Annual real GDP
growth rate GDP Positive
Market share Total Assets of the bank/Total assets of the industry at a given time
MKTSH
Positive
Source: Adopted from (Chong and Sufian, 2008)
35
CHAPTER FIVE
RESULTS AND DISCUSSION
5.1 INTRODUCTION
In this section, the researcher covered the ratio analysis, statistical analysis and
interpretation of fitting a regression model between liquidity and profitability of
selected banks listed on the Ghana Stock Exchange. The model is to identify whether
liquidity and other macro-economic indicator has a significant influence on the
performance of banks. The analysis was conducted with the aid of Microsoft Excel.
Based on the objectives of the study which are as follows:
• To examine the profitability trends and liquidity trends of listed banks on the
stock exchange over the period of study.
• To determine the extent to which banks profitability is affected by banks
liquidity.
• To determine the extent to which microeconomic variables affect the
profitability of listed banks.
5.2 DESCRIPTIVE STATISTICS
Table 5.1 present the descriptive statistics for the variables in the data set used for
the analysis in a quest to answer the research questions of the study. The table
revealed that the ratio of “total equity to total assets (CAR) was a proxy measure of
bank capital” it recorded a mean value of 13.56%. What this meant was that banks
on the GSE during this study period mobilised 13.56% of their fund needs through
equity capital while 86.44% was financed by deposits liabilities. The standard
deviation ratio was 7.33% with 0.012% minimum and 44% maximum.
36
Mean value for “loan to total assets” (LTA) was 42.5%. what this meant was that,
42.5% total assets were held by “loan and advances disbursed to customers”. 14.24%
was recorded as the standard deviation with 0% minimum value and 79.9%
maximum values respectively.
The “ratio of Liquidity (LQD) is measured by loans to total deposits ratio”. The mean
value of liquidity ratio was 62.0%; it shows that the sector was very liquid. The
standard deviation was 23.40%, minimum was 0% and 117% maximum.
Moving on to macro-economic and industry factors, GDPG showed that on average,
the Ghanaian economy had increased by 7.32% during the study time. This helps
banks in providing necessary loan for financing different investments. The minimum
3.58 and maximum 14.05.
Table 5.1 Descriptive Statistics
VARIABLE OBS. MEAN SD MIN MAX
ROA 64 0.0250 0.02 -0.007 0.075
CAR 64 0.1360 0.073 0.001 0.440
LQD 64 0.620 0.234 0.000 1.170
LTA 64 0.425 0.142 0.000 0.799
MKTSH 64 0.058 0.073 0.001 0.440
LOGTA 64 18.334 7.134 0.200 22.980
GDPG 64 7.318 3.334 3.580 14.050
INF 64 0.119 0.042 0.067 0.175
37
Note: SD represents standard deviation, OBS resents observation, Min represents
minimum and MAX represents maximum
Inflation (INF) observed a mean value of 11.95% and 4.21% as standard deviation
over the time frame. The minimum and maximum values were 0.67% and 17.46%
respectively.
Market share (MKTSH), the variable termed as industry structure variable. The mean
value was 5.82% with standard deviations of 7.34%. The result varies from 0.012%
and 44% as of minimum and maximum values. It showed that there were high
variations among banks pertaining to market share controlling capacity throughout
the study time.
5.2 TREND ANALYSIS OF LISTED BANKS
5.2.1 LIQUIDITY TRENDS FOR THE LISTED BANKS
The trend for net loans to total deposits for each of the banks in the sample over the
time period covered by the study is presented in figure 5.1. From the figure, Access
Bank observed the highest net loans to deposits ratio of 1.85 among the eight listed
banks which was too high. Typically, the ideal loan to deposit ratio for banks is 0.8-
0.9. This meant that the bank may not have enough liquidity to cover any unforeseen
fund.
Standard chartered Bank and Ecobank on the other hand were within the ideal ratio.
Cal Bank was slightly below the ideal ratio and hence equally had a strong liquidity
position. ADB was well below the ideal margin and this was not a good sign for the
bank with respects to their liquidity status. In 2011, Access Bank was still loaned up,
the liquidity positions of GCB improved tremendously from 0.64 to 0.90 and hence
had the strongest liquidity position in the market. 2012 saw a tremendous
38
improvement in the liquidity positions of Access Bank as it was not loaned up, also
there was a slight improvement among the other banks as well. However, in 2013,
None of the banks were within the ideal ratio and this could imply that the banks
were not able to adequately attract and retain their customers. The situation however
improved from 2014 to 2017 with all the eight banks having a fairly strong liquidity
position in the market. 4 out the 8 banks in 2017 were within the ideal ratio and the
other banks on other hand within these periods had liquidity ratios slightly below the
ideal margin and hence still possessed a strong liquidity position in the market.
Figure 5.1 Net loans to Total Deposits trend.
Source: Author’s calculation based on data.
0.64
0.90
0.82
0.78 0.
89
0.77
0.99
0.85
0.55
0.50 0.
58
0.57 0.62
0.57
0.83
0.84
1.85
1.13
0.86
0.64
0.56
0.55 0.57
0.870.
99
0.86
0.75
0.76
0.76
0.75 0.
87
0.86
0.79
0.68
0.67
0.62
0.62
0.57 0.
63 0.76
0.71
0.57
0.45
0.62
0.9
0.84
0.52
0.79
0.68
0.66
0.55
0.38 0.
50
0.70 0.
77
0.53
0 0 0
0.74 0.76
0.55
0.49
0.66
2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7
NET LOANS TO DEPOSIT TREND FOR THE LISTED BANKS
GCB NET-LOANS TO TOTAL DEPOSITS
ADB NET- LOANS TO TOTAL DEPOSITS
ACCESS BANK NET LOANS TO TOTAL DEPOSITS
STANDARD CHARTERED BANK NET LOANS TO TOTAL DEPOSITS
ECOBANK NET LOANS TO TOTAL DEPOSITS
CAL BANK NET LOANS TO TOTAL DEPOSITS
SG-SSB NET LOANS TO TOTAL DEPOSITS
REPUBLIC BANK NET LOANS TO TOTAL DEPOSITS
39
The trend for loans to total asset of each of the bank on the other hand is presented
in figure 4.2. The figure revealed that the industry loans to total assets in 2010 was
0.53, from the figure blow, in 2010, Access Bank loans to total asset ratio was higher
than the industry margin, hence the bank was loaned up as compared to the other
listed banks as well as banks in the industry. All the other banks with the exception
of ADB were slightly below the industry margin and as compared to the industry had
a strong liquidity position because they were not loaned up.
Figure 5.2 Loans to Total Assets for the banks
Source: Authors calculation based on data
The industry ratio for 2011 and 2012 were 0.54 and 0.49 respectively. GCB was
loaned up in 2011 as it had a ratio of 0.75 which was above industry limits. Access
bank on the other hand was able to beat down it loan to total asset ratio. The other
banks however had adequate loan to total asset ratios as compared to the industry.
GCB was still loaned up as compared to the industry in 2012. All the other banks had
0.48
0.75
0.64
0.61 0.
64
0.56 0.
60
0.59
0.29 0.
35 0.39
0.37 0.
42
0.40
0.61 0.62
0.86
0.67
0.58
0.47
0.42 0.43 0.
48
0.610.
65
0.65
0.53 0.55 0.56 0.57 0.
64 0.65
0.62
0.55
0.53
0.49
0.46
0.43 0.
50
0.61
0.49
0.49
0.44
0.30
0.41
0.49 0.
52
0.42
0 0 0
0.69
0.65
0.56
0.42
0.58
0.41 0.42
0.31 0.33
0.46
0.40
0.38
0.48
2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7
LOANS TO TOTAL ASSETS TRENDGCB LOANS TO TOTAL ASSETS ADB LOANS TO TOTAL ASSETS
ACCESS BANK LOANS TO TOTAL ASSETS STANDARD CHARTERED LOANS TO TOTAL ASSETS
ECOBANK LOANS TO TOTAL ASSETS SG-SSB LOANS TO TOTAL ASSETS
REPUBLIC BANK LOANS TO TOTAL ASSETS CAL BANK LOANS TO TOTAL ASSETS
40
adequate liquidity levels as compared to the industry. In 2013, the banks were either
slightly below or above the industry margin of 0.5 hence were holding strong
liquidity position in the market. Republic bank however was loaned up as it had a
high ratio of 0.69. In 2014 and 2015, Ecobank, GCB and Standard Chartered bank
had loan to assets ratio way above the industry level of 0.48. which means they did
not have a strong liquidity position as compared to the other banks. The remaining
banks how ever had ration slightly below the industry loan to total assets ratio. 2016
to 2017 saw a significant improvement in the bank’s loans to total asset ratio as
compared to the industry level of 0.61 the banks possessed strong liquidity positions
in these years.
Figure. 5.3 Liquidity Trends of the Listed Banks
Source: Authors calculation based on the data
From the average score of the selected bank of both loans to assets ratios and net
loans to total deposit ratios, the research concluded that the listed banks on the Ghana
Stock Exchange has a fairly stable liquidity position, the average also indicated that
the banks have strong liquidity position and they are not highly prone to default risks.
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
AVERAGE LIQUIDITY OF LISTED BANKS
NET-LOANS TO TOTAL DEPOSITS LOANS TO TOTAL ASSETS
41
5.2.2 Profitability Trends of Listed Banks
Generally, Return on Assets over 5.0% are considered good, however the banking
industry in 2010 observed an industry average 2.3%. From the figure above none of
the listed banks had a ROA above 5.0%, however, all the banks with except Cal bank
had ROAs above the industry average. This tell us that the banks were able to
generate profits well above industry levels in relation to their resource use. GCBs
ROA in 2011 fell way below the industry level of 2.4, all the other banks on the other
hand were able to adequately make good use of their resources to generate profits
above the industry level.
Figure 5.4 Return on Assets Trend for the listed banks
Source: Authors calculation based on the data.
The ROA level for the industry in 2012 was 3.4. the listed banks in the industry
performed considerably well as compared to the industry. ADB and GCB on the other
2.60
%
0.70
%
4.70
% 6.00
%
6.40
%
5.30
%
4.90
%
2.20
%3.30
%
2.80
%
1.80
%
5.00
%
2.20
%
-3.7
0% -2.3
0%
0.70
%
4.20
%
3.00
% 4.30
%
4.60
%
5.00
%
3.30
%
1.60
%
0.90
%
4.30
%
3.90
% 5.70
% 7.00
%
5.90
%
2.00
%
5.10
%
5.90
%
3.90
%
3.30
% 4.20
%
4.00
% 5.50
%
5.00
%
4.10
%
2.80
%
1.80
%
2.30
%
4.30
% 5.90
%
5.20
%
4.80
%
0.20
%
3.40
%
2.80
%
2.70
%
2.80
%
3.00
%
3.00
%
2.20
%
2.60
%
3.20
%
0.00
%
0.00
%
0.00
%
3.70
%
4.10
%
-2.5
0%
-2.1
0%
1.80
%
2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7
RETURN ON ASSETS FOR THE LISTED BANKS (2010-2017)
GCB ROA ADB ROA
ACCESS BANK ROA STANDARD CHARTERED BANK ROA
ECOBANK ROA CALL BANK ROA
SG-SSB ROA REPUBLIC BANK ROA
42
hand could not meet the industry performance level. 2013 saw a tremendous
improvement in the profitability levels as 6 out of the 8 listed banks had ROAs above
both the ideal levels of 5.0% and industry level of 4.2%. The performance of ADB
declined in 2014 while the other banks still showed strong profitability levels.
ADB and Republic bank experienced negative ROAs in 2015, this means the banks
resources were generating negative profits(losses). Industry ROA however stood at
2.9% all the other banks exceeded industry average with SG-SSB and Standard
Chartered bank falling below the industry margins. The situation was same in 2016
with ADB and Republic bank still experiencing negative ROAs, however they
recovered in 2017 and become profitable, but were below the industry margin of
2.8%. Access bank too was below the industry margin.
Figure 5.5 Return on Equity trend for the listed banks.
Source: Authors calculation based on the data.
22.6
0%
9.80
%
49.1
0%
45.3
0%
40.9
0%
30.0
0%
29.5
0%
19.1
0%
23.2
0%
19.1
0%
13.5
0% 28.7
0%
13.9
0%
-23.
70%
-15.
40%
5.50
%
9.60
%
8.60
% 20.4
0%
21.1
0%
29.4
0%
22.4
0%
9.80
%
6.30
%
36.8
0%
33.4
0% 43.8
0%
42.7
0%
39.4
0%
11.9
0% 29.3
0%
30.8
0%
28.0
0%
30.0
0%
37.0
0%
37.0
0% 47.0
0%
39.0
0%
36.0
0%
26.0
0%
12.0
0%
19.1
0%
24.9
0%
32.6
0%
35.8
0%
32.0
0%
35.8
0%
32.0
0%
21.9
0% 36.7
0% 48.5
0% 58.3
0%
79.8
0%
44.6
0%
46.2
0% 65.4
0%
0.00
%
22.0
0%
13.7
0%
38.1
0% 56.9
0%
-40.
80%
-40.
10%
25.3
0%
2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5 2 0 1 6 2 0 1 7
RETURN ON EQUITY FOR THE LISTED BANKS (2010-2017)
GCB ROE ADB ROE ACCESS BANK ROE
STANDARD CHARTERED BANK ROE ECOBANK ROE CAL BANK ROE
SG-SSB ROE REPUBLIC BANK ROE
43
From the figure above, GCB, ADB, Standard Chartered Bank, Ecobank and SG-SSB
all performed well above the industry average of 16.0% in 2010. This implies that
the banks were able to generate adequate profits from its shareholders investment.
The other banks however had ROEs below the industry average, which means they
were not as profitable as the other banks in the industry. All the banks except GCB
and Access bank performed above the industry average of 17.8 in 2011. The banks
performance continued to improve through the periods of 2012 to 2014, however, in
2015 and2016, ADB and Republic bank experienced negative ROEs, this means that
these banks were not profitable within these periods. The situation changed and there
was an improvement in these banks in 2017, however the performance of ADB was
below the industry margin of 19.7%. Republic Bank exceeded the industry margin.
5.3 FITTING THE LINEAR REGRESSION
5.3.1 Fixed effect model results.
This thesis used panel model to analyse the collected data. Panel model is a
combination of cross sectional and time series observations. For this study, fixed
effect model is selected. It is one of panel model which control for unobserved
heterogeneity among cross sectional units.
5.4 Panel Model Regression
This section of the study presents the results and discussions of the regression
econometrics analysis. To shed more light on the determinants of bank profitability
based on linear panel data (analysis of cross sectional and time series) regression
models specifically a fixed effect model as discussed in the methodology section
The regression results are reported in Table 5.1 and based on the adjusted R-square,
which indicates that about 46.7% of the variations in the dependent variable is
44
explained by the variations in the independent variables. The F-statistics also showed
that, on the whole, the included independent variables are significant factors in
explaining profitability of the selected banks, since the P-value of the test statistic is
less than 5 percent. This suggest that the model is significant at the 5 percent
significance level.
The coefficient of the variable representing equity to total assets ratio (CAR) showed
a positive coefficient on profitability (measured by ROA). It indicates the ability of
a bank to absorb losses and handle risk exposure with shareholders. Thus, a unit
increase in CAR would result in 0.076 increase in ROA which is significant at 10%
(ceteris paribus).
The ratio of Loans to total deposits (LQD) was positive and had no significant
relationship with profitability. Insufficient liquidity is one of the major reasons of
bank failures. However, holding liquid assets has an opportunity cost of higher
returns Nevertheless, the coefficient was small and was not statistically significant
even at the 10% level.
Turning to other explanatory variables, the magnitude of loan to total assets ratio
(LTA) was negative with insignificant effect on profitability even at 10% confidence
level.
On the other hand, growth rate of gross of domestic product (GDPG) had a negative
insignificant effect, suggesting that for the period understudy and the selected banks,
growth in GDP had no effect on profitability
45
Table5.2 Estimating of equation using fixed effects. 2010 - 2017
Dependent variable: bank performance (ROA) Independent variables
Coefficient t P
LQD 0.023 (0.016)
1.472 0.147
LTA -0.014 (0.024)
-0.585 0.561
MKTSH 0.510 (0.076)
6.532 0.000***
CAR 0.076 (0.044)
1.707 0.093*
LOGTA -0.001 (0.000)
-3.261 0.002***
GDP -0.001 (0.001)
-0.478 0.634
INF 0.097 (0.097)
1.153 0.254
CONSTANT -0.004 (0.022)
-0.166 0.869
Number of observations = 64
Adjusted R-squared = 46.7%
F (7, 56) = 8.893
[0.000]
Robust standard errors in parenthesis, ***p<0.01, **P<0.05 and *p<0.1, numbers in square brackets are p-values.
Inflation measures the overall percentage increase in Consumer Price Index (CPI) for
all goods and services. Inflation affects the real value of costs and revenues. Inflation
though positive is not significant even at 10% confidence level, suggesting that
inflation during the period covered by the study had no impact on ROA. At the end,
the ratio Market share (MKTSH) was estimated in this study so as to investigate
whether having high market share leads to high profitability or not. The result of
market share indicated a significant impact on bank profitability.
46
CHAPTER SIX
CONCLUSIONS AND RECOMMENDATIONS
6.1 INTRODUCTION
The summary and recommendation of this research are presented in this section, and
also relates the findings to previous findings of other researchers of a relative study.
Going forward, this chapter throws light on the limitation of this study as well as the
proposed research topics for further studies.
6.2 SUMMARY
Through accounting ratios, the bank’s net loan-to-total deposit, loans-to-total assets,
Capital ratio and profitability ratios were obtained for the listed banks on the Ghana
Stock Exchange, after which the values were analysed using Microsoft excel in other
to ascertain the findings to the research objectives and hypothesis. The results of the
study indicated that bank size as a proxy to natural logarithm of total assets (LOGTA)
had a negative relationship with profitability. Also, the coefficient of the variable
representing equity to total assets ratio (CAR) showed a positive coefficient on
profitability as it measured by ROA. Furthermore, the ratio of Loans to total deposits
(LQD) was positive, however it had an insignificant relationship with profitability
(ROA).
Growth rate of gross of domestic product (GDPG) had a negative insignificant
effect. Furthermore, the impact of Market share (MKTSH) was estimated in this
study so as to investigate whether having high market share leads to high profitability
or not. The result of market share indicated a significant impact on bank profitability.
47
6.3 RECOMMENDATION
The researcher suggests the following to stakeholders of the research work;
Banks should not rely too much on borrowed funds which will disadvantage them
from paying higher finance costs at the expense of the shareholders, also Banks
should encourage more direct investment by shareholders this will ensure the banks
coverage on borrowed funds.
6.4 LIMITATIONS
In a study of this nature, it would have been more appropriate to examine all banks
in Ghana and not considered only banks listed on the Ghana Stock Exchange. Also,
a study that covers a longer period of time would have yielded different results.
Also, the quality of the study depended only upon the accuracy, reliability and
validity of the secondary data (audited annual financial statements) collected from
GSE website. The approximation of the figures disclosed in the financial statements
might impact the results of the study.
6.5 FURTHER STUDIES
In pursuit of further research, the following topics should be considered;
The effect of liquidity on Profitability: A comparative study on listed and unlisted
banks.
Bank Liquidity on Bank profitability: A study on unlisted banks.
48
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