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International Journal of Empirical Finance

Vol. 2, No. 4, 2014, 143-151

Liquidity-Profitability Relationship in Bangladesh Banking Industry
Afia Akter1, Khaled Mahmud2
Abstract
This study explored the relationship between liquidity (measured as current ratio) and profitability (measured
as return on assets) in the banking industry in Bangladesh. We have considered twelve banks in four different
sectors (Government banks, Islami banks, multinational banks and private commercial banks). We tried to
figure out how much liquidity of a bank can explain its profitability. We ran linear regression to find out the
extent of relationship between bank’s liquidity and profitability (significance level was 10%). Individually all
the sectors show no significant relationship between liquidity and profitability. Even the overall banking
industry shows the same result. We considers year just before recession (2006) to post-recession (2011). We
showed graphically how liquidity and profitability of these sectors varied over last couple of years.
Government banks showed variable liquidity, while other sectors were steady. But, there were much
fluctuations in profitability in between these times in all the sectors. Finally, we concluded that based on our
sample and category, there is no significant relationship between liquidity and profitability in banks of
different sectors in Bangladesh.
Keyword: Liquidity, Profitability, Relationship, Bangladesh, Banks.
1. Introduction
Banking is one of the most sensitive businesses all over the world and they are playing very important
role in economy. They do influence and facilitate to integrate the economic activities like resources
mobilization, production activities, distribution of public finance, and often social wellbeing. Banking Sector
of Bangladesh consists of private commercial Banks, islami banks, multinational bank, government banks,
and the Central Bank of Bangladesh.
Liquidity and profitability are two very crucial issues that organization’s management always considers
evaluating the financial health of the company. There is an extensive body of literature that seeks to identify
the determinants of financial performance of banks. Hultman and McGee (1989), and Peek et al. (1999)
focus on the understanding of foreign bank’s performance in a particular country. In contrast, John (2004),
and Khalid (2006) report the determinants of growth and bank’s profitability. It is widely acknowledged that
liquidity is one of the driving factors affecting the likelihood of a bank failure (Arena 2008).
Liquidity is a measure of the availability of cash for use in the day to day business. A liquid asset is one
that is cash or can easily be turned into cash. Liquidity plays a crucial role to both the internal and external
analysts because of its close relationship with day-to-day operations of a business (Bhunia, 2010). Weaker
liquidity position poses a threat to the solvency as well as profitability of a firm and makes it unstable
(Niresh, 2012). 'Current ratio' and the 'quick ratio' are two common measures of the liquidity of a company.
Usually a high current ratio is considered to be an indicator of the firm's ability to promptly meet its shortterm liabilities.
Profitability is a measure of the amount by which a firm’s revenues exceeds its relevant expenses
(Niresh, 2012). It is the potential of making profits that encourage entrepreneurs to take risks to invest in a
1
2

Assistant Professor Department of Business Administration Northern University Bangladesh
Assistant Professor Institute of Business Administration University of Dhaka Bangladesh

© 2014 Research Academy of Social Sciences
http://www.rassweb.com

143

the present study is an initiative to identify the relationship between liquidity and profitability of listed banks in Bangladesh. Section four focuses on results and analysis while fifth section concludes the study. 1980). 2012. there is no existing empirical work directly focusing on the specific question considered in the current paper. Bordeleau and Graham (2010) in their study found that the impact on profitability of a bank’s holdings of liquid assets (i. (2008) investigate the relationship between bank risk and profit structure. Gross profit margin is an indicator of the profit a business after cost of goods sold. 2010). 2013. 2012). After this introduction. However. Excessive liquidity indicates idle funds that don’t fetch any profits for the firm (Smith. selling and so on. This profit is earned before any administration. Berger (1995) analyses the statistical relationships between bank earnings and capital for US banks over the period of 1983-1989. A low profit margin would suggest ineffective management and investors would be hesitant to invest in the company. Patel.A. Hence. Moreover. so the first role of profits is to reward owners for risks taken when investing in a business.e. the net section is a review of related studies done previously. Empirical Studies There have been a large number of empirical studies on liquidity profitability analysis of firms around the world (Ajanthan. It is also conceptually applicable to the impact of liquid assets on profitability. there is not much study on Bangladesh. The study has five sections.  To find the nature and extent of the relationship between liquidity and profitability. the selling and distributions costs and all other relevant costs. 2013. While a very limited number of studies emerge to include liquidity as an explanatory variable for bank profitability or vis-veras (Bordeleau. it is justified that bank liquidity and profitability investigation started to increase from both scholars and industry specialists. (Niresh. insufficient liquidity might deteriorate firm’s credit standings and that might lead to forced liquidation of firm’s assets (Ajanth. To our knowledge. Lepetit et al. Section three discusses the methodology of the study. The study represents that banks expanding into non-interest income activities present higher insolvency risk than banks. This study analyses the liquidity and profitability ratios of different sectors’ commercial banks in Bangladesh over a six-year period. we are able to draw on relevant concepts in some related literature dealing with relationship between liquidity and profitability of different sectors. Research Question The following questions are addressed to identify the relationship (if any) between liquidity and profitability:  Is there any relationship between liquidity and profitability in banks of Bangladesh?  What is the nature and extent of the relationship between liquidity and profitability in these banks? Objectives of the Study  To identify the relationship between liquidity and profitability in banking sector of Bangladesh. On the other hand. Akter & K. Profitability is a measure of the amount by which a company's revenues exceeds its relevant expenses (Owolabi et al. Aminu. reserves) depends on the amount of funding that comes due in the short-term and on the 144 . 2013). However. Profitability ratios are used to evaluate the management's ability to create earnings from revenue-generating bases within the organization. with the deteriorating health of the banking institutions and the recent surge of bank failures as a result of the current global financial crisis. Demirgüç-Kunt and Huizinga (2010) support this finding of increased bank fragility associated with a high proportion of non-interest income and non-deposit funding. Nirish 2012). 2. Net profit margin is an indicator of the amount of net profit after taking account of the cost of sales. the administration costs. Berger applies the concept of the “Expected Bankruptcy Cost Hypothesis” in the realm of capital. Mahmud business.. which mainly supply loans. 2011).

International Journal of Empirical Finance general state of the economic cycle. collected data were analyzed by employing Correlation technique. For liquidity measure we considered current assets-liabilities ratio. Since our study focuses on the relationship between liquidity and profitability relationship between domestic and foreign banks. if a bank is more reliant on short-term funding. Correlation analysis technique is used to determine the nature and extent of the relationship. while regression analysis technique is used to determine whether cause-and-effect relationship exists between liquidity and profitability. Eljelly (2004) in his paper found a significant negative relationship between the firm’s profitability and liquidity levels. more liquidity implies less profitability. Their findings suggested that liquidity strategies do not have significant impact on Return On Assets (ROA). authors suggest banks should strike a balance between liquidity and profitability to meet regulatory requirement as well as shareholders’ wealth aspirations. Correlation coefficient is computed from liquidity and profitability ratios derived from six-year financial statements of the selected banks. The research conducted by Walt (2009) emphasizes more importance on profitability because profit can usually be turned into a liquid asset. Jose et al (1996) showed that day-to-day management of a firm’s short term assets and liabilities plays an important role in the success of the firm. To determine the nature and extent of the relationship. All else equal.0 Version was used in order to examine the data. however. The study proofs that there is a trade-off between liquidity and profitability in the banking business and these two reinforce each other in the manufacturing and processing businesses. the cash conversion cycle is of more importance as a measure of liquidity than current ratio. The study shows the cause as a bank maintains liquidity as regulatory requirement. Islamic. To find out the relationship between profitability and liquidity Raheman and Nasr (2007) conducted a study on several Pakistani firms listed on Karachi Stock Exchange and found that there is a strong negative relationship between liquidity and profitability. They investigate liquidity-profitability relationship in three different business sectors like banking. this study is based on time series data extracted from annual reports for the relevant six years period (from the 2006 to 2011). In conclusion. A well-known statistical package like ‘Statistical Package for Social Sciences’ (SPSS) 16. Lanberg and Valming (2009) conducted a study on companies listed on Shochholm Stock Exchange to find out the impact of liquidity on profitability. growth and expansion depend on profitability. scholarly articles from academic journals and relevant textbooks were also used. Don (2009) expresses that liquidity is more important as immediate survival of the company depends on it. The bank-specific data being examined in this study are derived from both the income statements and balance sheets of commercial banks published in the website. The study used secondary data for these analyses. Methodology of the Study In this study. and vice versa. Owolabi et al (2011) express in their paper that the survival of a business depends on its liquidity. we tried to find out the relationship between liquidity and profitability in the selected banks in Bangladesh. For the banking sector. Therefore both are important for any company. Multinational. 3. The study also found that at industry level. The study results show that liquidity and profitability are negatively correlated in a banking organization while they are positively correlated in a manufacturing and processing organization. Similarly. regressions & descriptive statistics. In addition to this. while profitability measure was considered Return on Asset (ROA) ratio. processing and manufacturing companies in Nigeria. since it is necessary to remain in operation. Its long-term survival. 145 . especially raw material inputs. The sample of this study is confined to banking area consists of 12 banks. we split the sample into four sub-samples according to their ownership namely. it may need to hold more liquid assets in order to maximize profits and continue its operation. where as Manufacturing firms should pursue profit maximization since so doing simultaneously enhances liquidity and Processing firms should always ensure adequate liquidity. However. Public and Private sector.

000022866 -------------+-----------------------------Total | .575 -. Std. Interval] -------------+---------------------------------------------------------------cr | -.0069499 _cons | .0245744 ------------------------------------------------------------------------------ R-square is 0. Regression Analysis Government Banks Source | SS df MS -------------+-----------------------------Model | 6. the simple linear regression model below is specified.12 0. Mahmud Simple linear regression model is used for empirical investigation and analysis of the relationship between liquidity and profitability.35 0.7477e-06 1 2.0182364 ------------------------------------------------------------------------------ R-square is 2.000302694 15 .028 .00002018 Number of obs F (1. Functionally.0049669 -0. Err. Results and Discussion We have run the regression for different categories of bank.733 -.0043217 2. which means at 90% level of significance there is no significant relationship between current ratio (CR) and return on asset (ROA).0106247 .000365857 16 . The respective model’s theoretical version is profitability (PFTY) depends on liquidity (LQTY).575 > 0. The model has designed based on assumed dual functional relationship of liquidity and profitability. Private Commercial Banks Source | SS df MS -------------+-----------------------------Model | 2. Islamic Banks Source | SS df MS Number of obs = 16 146 . Interval] -------------+---------------------------------------------------------------cr | -. So.000368604 17 . which means at 90% level of significance there is no significant relationship between current ratio (CR) and return on asset (ROA). I From these functional relationship. PFTY = f(LQTY) ……………………….0067635 .10.0045309 _cons | .0546 . 14) Prob > F R-squared Adj R-squared Root MSE = = = = = = 16 0. t P>|t| [90% Conf.75%.0038177 -0. 4.0017218 .9715e-06 Residual | . Std.10.A.733 > 0.30%.46 0. P-value is 0.07 0.0103934 . results are presented into five categories.0075 -0.0046 -----------------------------------------------------------------------------roa | Coef. Then we also have run the regression for the total banking industry of Bangladesh.33 0. Akter & K. Err.0030129 .00478 -----------------------------------------------------------------------------roa | Coef.000295723 14 .0468 . µ is the stochastic term depicting influence of other factors that affect liquidity and profitability but which is not included in the model. P-value is 0.9715e-06 1 6.0021932 .5747 0. t P>|t| [90% Conf.0089173 .0051008 3.0230 -0. PFTY = λ0 + λ1LQTY + µ ……………… II Where λ0 is the intercept of the regression lines and λ1 is the slope coefficient to capture the nature and effect of the relationship between the variables.57 0.000021123 -------------+-----------------------------Total | . 16) Prob > F R-squared Adj R-squared Root MSE = = = = = = 18 0.7477e-06 Residual | .007 .000021683 Number of obs F (1.7334 0.0156689 .

528 -. Std.1817999 .000076712 Number of obs F (1.0338212 ------------------------------------------------------------------------------ R-square is 5. t P>|t| [90% Conf.0055405 2.0488129 .005139561 66 .05878 _cons | -.10. if there is any.00 0.393 -.965 > 0. which means at 90% level of significance there is no significant relationship between current ratio (CR) and return on asset (ROA).000627563 14 .23 0. Err.002839976 16 .78 Prob > F = 0.0439023 .0152 Root MSE = .0089051 _cons | .10.061054 .0218259 0.0067 -----------------------------------------------------------------------------roa | Coef.0052005 0. 16) Prob > F R-squared Adj R-squared Root MSE = = = = = = 18 0.0610688 .000044155 F (1.0084465 . Std.10. which means at 90% level of significance there is no significant relationship between current ratio (CR) and return on asset (ROA). Correlation between these factors to look at the direction of relationship.000159264 Residual | .0525 Adj R-squared = -0. P-value is 0.0693363 0.0151 .000177498 -------------+-----------------------------Total | . P-value is 0.358 -. From all the regressions. Interval] -------------+---------------------------------------------------------------cr | .965 -.358 > 0.0531 -0.000662319 15 . Overall Banking Industry Source | SS df MS -------------+-----------------------------Model | 1.3576 0.5144e-07 Residual | . Interval] -------------+---------------------------------------------------------------cr | .0755046 -0.0841741 ------------------------------------------------------------------------------ R-square value is 5. P-value is 0.005139712 67 . we can see that there is no significant relationship between liquidity (CR) and profitability (ROA) in all types of banks and even in the overall banking industry in Bangladesh.0174311 .0137338 .04 0.01332 -----------------------------------------------------------------------------roa | Coef.000176426 Number of obs F (1.9650 0. Err.1831768 _cons | -.0000 -0. which means at 90% level of significance there is no significant relationship between current ratio (CR) and return on asset (ROA).00882 -----------------------------------------------------------------------------roa | Coef.0050405 .000077872 -------------+-----------------------------Total | . t P>|t| [90% Conf. Government Banks | roa cr -------------+------------------ 147 .824 -.393 > 0.000034757 Residual | .31%.0206745 .0061 . 66) Prob > F R-squared Adj R-squared Root MSE = = = = = = 68 0.88 0. Multinational Banks Source | SS df MS -------------+-----------------------------Model | .00299924 17 .000159264 1 . Std.0229768 ------------------------------------------------------------------------------ R-square is 0.3934 R-squared = 0.000044826 -------------+-----------------------------Total | .International Journal of Empirical Finance -------------+-----------------------------Model | .95 0.0002293 . 14) = 0.0044908 .00%.016 . Err.0222591 -0.5144e-07 1 1. Correlation Analysis We also tried to look at the correlation coefficient between liquidity (CR) and profitability (ROA).90 0.48 0.65 0.000034757 1 .25%. Interval] -------------+---------------------------------------------------------------cr | . t P>|t| [90% Conf.

A. Multinational Banks | roa cr -------------+-----------------roa | 1. 5. But for banking industry in Bangladesh.0863 1.0000 cr | 0. it shows there is no significant impact of liquidity on profitability.2291 1.0000 Correlation coefficient between return on asset and current ratio for multinational banks show positive relationship and in this case the relationship is almost same as islami banks.0000 cr | 0.0000 Correlation coefficient between return on asset and current ratio for private commercial banks is also negative and the strength of association is weaker than government banks. All our analyses show that all the models can explain very small amount of dependency with no significance at 10% level of significance.2304 1.0000 cr | 0. 148 .0000 For overall banking industry.1518 1. Although multinational and islami banks show positive correlation coefficient. Islamic Banks | roa cr -------------+-----------------roa | 1. correlation coefficient between return on asset and current ratio shows almost no relationship. there are no significant relationships between liquidity and profitability.0000 -0. Definitely liquidity has impact on short-term operations of any firm.0000 Correlation coefficient between return on asset and current ratio for government banks is negative and very weak. Private Commercial Banks | roa cr -------------+-----------------roa | 1.0000 cr | -0. Even as a total industry there is no significant relationship between liquidity and profitability. Overall Banking Industry | roa cr -------------+-----------------roa | 1. Mahmud roa | cr | 1.0000 Correlation coefficient between return on asset and current ratio for islami banks show positive relationship and in this case the relationship is also weak but moderately better than the other two types of banks.0054 1. Akter & K. Discussion of Results These results reveal that there is no significant relationship exists between liquidity and profitability in all the categories on banks in Bangladesh.

Liquidity shows the strength of the banks in terms of their operations and profitability shows their effective and efficient value maximization over the period of time. But profitability tells us a different story (fig. we will look into other variables to look at how they can explain profitability more.50% Islami Bank 1. we can say that there is no significant relationship between liquidity (measured as current ratio) and profitability (measured as return on asset) in these banks.00% Pvt Commercial Bank 0. This also explains no significant relationships between liquidity and profitability in banking industry of Bangladesh. government banks show more variability in current ratios over that period of time. In our future work. Islami banks show a steady current ratio over the years. Return on Asset of all these categories of banks show similar amount of variability over the same time period.6 0.4 Multinational 0. 2.00% Government Bank 1.50% Multinational 0. We also will expand our study horizon to different industry and will try to show a comparative analysis. On the other hand. 2).50% 2. Conclusion Our analysis has shown the degree of relative relevance of liquidity and profitability in the four sectors of banks in Bangladesh. Multinational banks and Private commercial banks also show steady current ratio.00% 2006 2007 2008 2009 2010 2011 Figure 2: Return on Asset of different types of banks in Bangladesh from 2006 to 2011 6. References 149 .2 0 2006 2007 2008 2009 2010 2011 Figure 1: Current ratio of different types of banks in Bangladesh from 2006 to 2011 We also plotted the data of current ratio of different bank categories of Bangladesh from 2006 to 2011.4 Government Bank 1. Still.6 1.8 Pvt Commercial Bank 0. From the analysis. liquidity is very important for any institutions and profitability shows the financial strength of that institution.2 1 Islami Bank 0.International Journal of Empirical Finance 1. Figure 1 shows the pattern.

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