Atif ullah

BCM-17-21

Submitted TO:

Sir Amir Sohail

Examination the impact of liquidity risk on bank
financial performance: empirical evidence from
Pakistan

1. Theory of Liquidity

 Anticipated Income Theory

According to Alasthi (2014) firms can deal with liquidity problem by giving
advancesthrough appropriate techniques and then collecting these advances in time when they
becomedue as well as decrease the reimbursement postponement at the due time. Mercy, (2013)
reported if the creditor’s prospect revenue ofa companyincrease than creditor can pay backthe
credit installment in specified period of time and with the help of this refund the required
liquidity state of the bank is upheld. According to Sobyibo, ﴾2004﴿ the anticipated theory of
liquidity significantly focuses on long term advances. The long terms advances that are prudent
for the banks as well as creditor ability and power to payback advances in a specified period.

Shiftability Theory

The shiftability theory was an extension to the commercial loan theory. The theory
is based on the proposition that the assets of the bank could either be sold to other
lenders or investors or shifted to the central bank. In particular, a bank could satisfy
its liquidity requirements if it held loans and securities that could be sold in the
secondary market prior to maturity. The ability to sell government securities and
eligible paper effectively substituted for illiquid, longer-term loans with infrequent
principal payments. A commercial bank would be able to meet its liquidity needs if
it had assets to sell (Crosse and Hempel, 1980; Santomero, 1984; Tobin and Brown,
2003).The shiftability theory had a profound influence on banking practices by
shifting the attention of bankers and banking authorities from loans to investments
as a source of liquidity. A bank holding short-term money market instruments such
as Treasury bills (TBs) or call loans is actually in a better position to shift its assets
than a bank holdingcustomer notes, since the open market debt can be sold before
maturity if necessary. As Luckett (1984) indicated, the liquidity position of a bank
consequently came to be associated with the amount of money market instruments
it was holding (its secondary reserves).The shiftability theory had a major
weakness, which however, according to Luckett (1984), does not lie in the theory
itself, as it is well understood by the various writers on the subject. The flaw in the
shiftability theory was that although one bank could raise liquidity by shifting its
 assets, the same strategy would not work if all banks attempted to shift at the same
time. This is what logicians call “the fallacy of composition”, that is the supposition
that what is true if one member of a set behaves in a particular way will continue to
be true when all members of the set behave that way. Clearly, all banks cannot gain
additional cash reserves by shifting their earning assets to one another. This
problem becomes acute in times of crisis. Machiraju (2008) highlighted that
liquidity problems could arise if the market prices of securities fall and loans are
only liquidated at a loss.The shiftability theory suffers from the weakness that in
periods of economic crisis, banks cannot all raise additional liquidity simply by
shifting assets. This is because there is selling pressure as all banks attempt to raise
funds and buyers are difficult to find. Where a seller manages to sell an asset, the
sale will be at a huge discount, representing an appreciable loss in value. The price
is not at all predictable. Assets that are liquid during normal times may therefore be
relatively illiquid in periods of economic crisis.In 1929-1933, all the US banks
wanted to be sellers and none wanted to buy. What was needed was some agency
outside the banking system to chip in with funds and buy all the assets available for
sale. This was the purpose for which the Federal Reserve Systems (FRS) had been
set up, but it acted rather sluggishly, resulting in a banking crisis that could have
been abated if the “right” thing had been done (Luckett, 1984). The problem of the
liquidity of the whole banking system is simply not solvable by commercial
banksalone. A central bank that is prepared to act quickly and decisively is an
absolute necessity.

 Commercial Loan Theory:

The commercial loan theory maintained that commercial bank liquidity would be assured as
long as assets were held in short-term loans that would be liquidated in the normal course of
business. Banks were expected to finance the movement of goods through the successive stages of
production to consumption. The commercial loan theory holds that banks should lend only on “short-
term, self-liquidating, commercial paper”. The theory was designed to finance trade. It was in line
with what is called working capital loans or inventory today. Loans should be based on “real” goods
as opposed to loans for speculative or purely financial purposes, hence the alternative phrase; the real
bills doctrine (Luckett, 1984; Reed and Gill, 1989; Machiraju, 2008).Various researchers criticized
the commercial loan theory. Luckett (1984) maintained that the theory prohibits the making of
longer-term loans, which are considered illiquid. The basic argument is that the liabilities of a bank
are payable on demand and the bank cannot therefore meet its obligations if assets are tied up for
longer periods of time. Rather, A bank needs a continual and substantial flow of cash moving
through it in order to maintain its own liquidity, and this cash flow can only be attained if the bank
limits its lending activities to shorter-term maturities. Reed and Gill (1989) observed that the
commercial loan theory failed to take into account the needs of the economy. In the US, banks
rigidly adhered to the theory and were prohibited from financing expansion of plant and equipment,
house purchases, livestock acquisition and land purchases. The ultimate result was the birth of
competing financial institutions such as mutual savings banks, savings and loan associations and
credit unions, among others. Luckett (1984) concurred that the commercial loan theory is flawed by
serious misconceptions, both analytical and historical. On a theoretical level, the most basic
weakness of the real bills doctrine is that it has misconceived the nature of what is and is not “real”.
The fact that a bank is making a loan against physical goods does not guarantee the full repayment of
the loan. This is because the value of the goods may fall appreciably and this may impair the ability
of the borrower to repay the loan. In short, therefore, the bank does not lend against the goods bought
by the funds so advanced, but against the value of those goods, which may decrease. Hence, there is
a speculative element to any loan, whether or not it has real goods as its immediate source. It
therefore follows, that even if banks had adhered rigidly to the tenets of the commercial loan theory,
they would still have been vulnerable to bankruptcy during the depressions of the nineteenth century.
A bank’s liquidity is not fully guaranteed unless its loans are entirely safe and liquid (Smith, 1991).
Commercial loans are not liquid unless the bank can demand repayment at any time. They are not
safe unless it is certain that the financed goods will, in fact, be sold. However, the theory assumes
that all commercial loans would be liquidated in the normal course of business. While businesses
have no difficulty meeting their obligations during periods when economic activity is high, in
periods of economic recession, the movement of goods from cash to inventory, to sales, to accounts
receivable, to cash is interrupted, and business finds it difficult, if not impossible, to liquidate bank
credit (Reed & Gill, 1989). The real bills doctrine asserts that liquidity crises are less likely when
banks hold short-term liquid assets. However, as Smith (1991) noted, the real bills doctrine is not
sufficient to avoid liquidity crises, especially during periods of economic crisis. Another important
critique was that the commercial loan theory did not take into account the relative stability of core
bank deposits (Machiraju, 2008). Core deposits enable a bank to extend loans for reasonably long
periods without being illiquid. However, the relative stability of deposits can be questioned in times
of economic crisis when confidence in the banking system is usually at an all-time low and
depositors maintain accounts largely for transaction purposes. This trend supports the extension of
only short-term loans, as advocated by the real bills doctrine. Despite the critics, the commercial loan
theory has been a persistent theory of banking. Remnants of it still remain in the structure of bank
regulatory agencies, bank examination procedures, and the thinking of many bankers.

 Liability Management Theory:

The liability management theory presents that banks can satisfy their liquidity needs by
borrowing in the money and capital markets. According to this theory, banks can meet their liquidity
requirements by bidding in the market for additional funds to meet loan demand and deposit
withdrawals. When in need of immediate available funds, banks can simply borrow via Federal
funds, repos, commercial paper and Eurodollars. The liability management theory became
increasingly popular as banks gained the ability to pay market interest rates on large liabilities. The
fundamental contribution of the theory was consideration of both sides of a bank’s balance sheet as
sources of liquidity. Today, banks use both assets and liabilities to meet liquidity needs. Available
liquidity sources are identified and compared to expected needs by a bank’s Asset and Liability
Committee. Management considers all potential deposit outflows and inflows when deciding how to
allocate assets and finance operations. Key considerations include maintaining high asset quality and
a strong capital base that reduces liquidity needs and improves a bank’s access to funds at low cost
(Koch & Scott, 2008). In a broad sense, liability management consists of the activities involved in
obtaining funds from depositors and other creditors and determining the appropriate mix of funds for
a particular bank. In a narrower sense, liability management has come to be known as the activities
involved in supplementing liquidity by actively seeking borrowed funds when needed (Reed & Gill,
1989). The term “liability management” is something of a misnomer (Luckett, 1984). It does not
mean that the bank only manages its liabilities and is passive with respect to its assets. Rather, the
theory also recognizes that the asset structure of a bank plays a prominent role in providing a bank
with liquidity. But the theory goes on to argue that the bank can also use its liabilities for liquidity
purposes. The ability to sell certificates of deposit, to sell securities under repurchase agreements
(repos), and to borrow Eurodollars enables a bank to rely less on low-earning secondary reserve
assets for liquidity, which may enhance the earning power of a bank. However, as Reed and Gill
(1989) point out, these activities are not without risk. Instead, liability management requires
consideration of the extra risk as well as the difference between the cost of obtaining funds and the
return that can be earned when the funds are invested in loans or securities. Thus, the relationship
between asset management and liability management is a critical determinant of a bank’s
profitability. As Luckett (1984) indicated, a number of observers have expressed serious reservations
about liability management banking, because the theory and practice seem to be flawed in the same
way that the shift ability theory was flawed. Specifically, while any individual bank can acquire
funds through selling liabilities, the entire banking system cannot. Thus the concern is that a
financial panic might very quickly eliminate the liability markets, as viable sources of liquidity, and
banks that place too much reliance on them would find themselves in deep financial difficulties. The
liquidity management theories are essential in this research study in helping analyse liquidity
management by commercial banks in challenging operating environments. One would want to
investigate which of the liquidity management theories Zimbabwean commercial banks adopted to
manage liquidity risk. Liquidity and Liquidity Risk Defined Bank liquidity is the ability of a bank to
fund increasing assets and meet obligations when due, without incurring unacceptable losses
(Harrington, 1987; Cates, 1990; Cooper and Thomas, 1998; Freixas and Rochet, 1999; Holmstrom
and Tirole, 2000; Sinkey, 2002;Tobin and Brown, 2003; Van Greuning and Bratavonic, 2003;
Agenor et al., 2004;Aspachs et al., 2005; Dev and Vandara, 2006; Karcheva, 2006; Acerbi and
Scandolo, 2008; Machiraju, 2008; Bessis, 2009; Drehmann and Nikolaou, 2009; Moore, 2010;Ismal,
2010). Failure by the banks to manage liquidity brings about liquidity risk. According to Machiraju
(2008), liquidity risk covers all risks associated with a bank failing to meet its obligations in time or
only being able to do so by emergency borrowing at high cost. The Bank for International
Settlements (BIS) (2008a) defines liquidity risk as the risk of a bank being unable to obtain funds at a
reasonable price within a reasonable time period to meet its commitments. Liquidity risk is the risk
to a bank's earnings and capital arising from its inability to meet obligations when due, without
incurring unacceptable losses (Bessis, 2009). From the given definitions, one can conclude that all
financial institutions that engage in maturity intermediation, borrowing short and lending long, are
necessarily placed in a potentially illiquid position. The term “liquidity risk” includes two types of
risk: funding liquidity risk and market liquidity risk. Funding liquidity risk is the risk that a bank will
fail to efficiently meet both expected and unexpected current and future cash flow and collateral
needs without affecting either daily operations or the financial condition of the firm (Aspachs et al.,
2005; Vento and Ganga, 2009). Accordingly, funding risk is a function of market perceptions on the
credit standing and reputation of the bank. Market liquidity risk is the risk that a bank cannot easily
offset or eliminate a position at the market price because of inadequate market depth or market
disruption (Nikolau, 2009; Vento and Ganga, 2009; Drehmann and Nikolaou, 2009). There is a
strong relationship between funding liquidity risk and market liquidity risk. Lower market liquidity
leads to higher margins, which increases funding liquidity risk (Brunnermeir, 2009). In addition,
Vodova (2011) shows that it is more evident if the shocks to funding liquidity can lead to asset sales,
leading to a decrease in asset prices. Liquidity risk dynamics therefore vary according to a bank's
funding market, balance sheet, and inter-corporate structure. The most common signs of possible
liquidity problems include rising funding costs; requests for collateral; a rating downgrade;
concentrations in either assets or liabilities; rapid assets growth funded by volatile large deposits;
decreases in credit lines; large off-balance sheet exposures; or reductions in the availability of long-
term funds (Goacher, 2002; Anas and Mounira, 2008; Berger and Bouwman, 2009; Bessis, 2009;
Chikoko and Le Roux, 2011). For the purposes of this thesis, funding liquidity risk is regarded as
liquidity risk. Bank management must ensure that sufficient funds are available at a reasonable cost
to meet potential demand from both fund providers and borrowers.
 Nature of liquidity risk in the banking sector:
The definition of liquidity risk management as provided by Ismail (2010) refers to the
situation when a bank either is unable to meet the cash demands of its depositors or is unable to
invest into situation whereby depositors of the banks collectively want to withdraw their money and
this demand for money exceeds the supply a bank could arrange in a short span of time. Apart from
that, banks also face liquidity threats when the borrowers of the banks are unable to pay back their
financial obligations on time. So, liquidity risk could arise out of the liability side of the banks,
where depositors want their deposits to be repaid, and out of the assets side, when borrowers are not
able to pay their obligations on time. So the liquidity problems arises in two situations, first is when
the bank decides to terminate a loan and the borrower is not in a position to pay back the money and
second is when depositors want their money back and the bank is not in a position to return it
(Thakor, 1995), Zhu (2001) elaborated that banks accept liquid cash from liability side and invest
that money in long-term assets that are not that liquid, so the nature of banking business invites gaps
between liability-side cash requirements from customers and asset-side cash generation from the
borrowers. There are established practices to manage this gap and if any bank is not able to manage
this gap, liquidity risk materializes. This occurrence of liquidity-related issue could also lead the
bank towards reputational damage, government bailout and in extreme cases towards insolvency.
Such liquidity problems might arise due to inefficiencies related to the arrangement of external or
internal funds, condition of the bank at the time of liquidity issue, inability to prepare liquid
instruments and the strength of liquidity risk or pressure. Highlights some of the external and internal
factors that cause a bank to face liquidity-related issues and problems. Conventionally, ratio analysis
is considered one of the most simple and usable ways to determine the liquidity position of banks.
There are four types of financial ratios: liquidity ratio, ratio of demand deposit to private sector
credit, NPLs ratio and loan to deposit ratio. The first form of the ratio is related to the liquidity
prospects of the bank, whereby current assets and current liabilities of the banks are compared and
evaluated. Then there are economic implications as well; Moreno (2006) stated that current ratios of
certain economies might be higher in countries in which:
i. Governmental support is not available to banks for liquidity management
ii. Financial players are risk averse in nature
iii. Deposits are fixed interest based
iv. Hedging, risk diversification or risk transfer mechanisms are not in place.
A survey conducted in 2006 by Bank for International Settlements (BIS) claimed that
countries like Hungary, Saudi Arabia, Mexico, Hong Kong, Poland, Turkey, Czech Republic and
Korea have higher liquidity ratios due to the above-mentioned reasons. The second ratio in the
context of liquidity evaluation is the ratio of demand deposit to private sector credit. Advances to
private sector are not that liquid and are considered long-term commitments, while the tendency of a
bank to rely more on demand deposits could cause a mismatch between asset and liability sides of
the bank. The third ratio in this regard relates to the NPLs of the bank and is termed NPL ratio. The
higher the NPL ratio the higher the mismatch would be between asset and liability side and more
would be the losses for the banks. Lastly, loan to deposit ratio measures the percentage of the
deposits that are advanced to the borrower. The higher this ratio, the higher would be the need of
liquidity for the banks. Higher liquidity reserves could meet this need. Failing to meet liquidity
reserve requirements could raise liquidity-related problems for the bank.
  Liquidity Risk Management Process:
BIS stresses that banks should identify, measure, monitor and control their liquidity risk and
all liquidity management measures should be taken in the context of the economic scenario in which
they operate (BIS, 2008a). Liquidity risk management process of the banks relies on four elements.
The first element in this process is composed of initiatives and policies of the board of directors
(BOD) of banks for liquidity management; the second element rests with the role and initiatives of
Asset Liability Committee (ALCO). The third element considers usability of information
management system, which helps to monitor and report liquidity risk; the fourth element is based on
the role of the internal control system, which ensures an effective liquidity management process.
Following is a brief discussion on each of these four elements in detail.

 Techniques to Mitigate Liquidity Risk:

Gap analysis is a widely-used technique for analyzing and managing interest-rate risk. It is
also applicable for liquidity risk. According to Heffernan (2005), the technique of gap analysis is
used to find the difference between the asset side and liability side output over a period of time. It is
recommended that banking institution should have a positive gap, which means assets exceed
liabilities. Bank covered the mismatch between assets and liability through rising interest rate, but it
increases non-performing loan and Interrupts the performance of the asset side.Basel committee of
banking supervision (BCBS, 2008) suggested for banking institutions to expand their funding
sources, or enhance liquidity sources. Banking institution requires fulfilling the daily need of
depositors and maintaining regular and irregular liquidity demand. Regular banking activities create
regular liquidity demand. While irregular demand may predict irregular demand or unpredictable
liquidity demand. The non-routine business operation such as withdrawal of government for fiscal
operation and execution of non-mature time deposit arises from regular liquidity demand. Irregular
liquidity demand arises from sudden events such as banking crisis, economic or financial crisis,
social and political instability, and natural disaster. To fulfill the regular liquidity demand banking
institution, maintain reserve account on the asset side. Reserve account is a pool of the fund that can
be used to provide liquidity when needed. As noted by Hempel, Simonson, and Coleman (1994)
banks fulfill the demand of liquidity through maintaining cash in vault, commercial bank deposit,
central bank certificates, and other cash items. Based on the experience bank should estimate
predictable irregular, and short-term liquidity demands. Stuart I Greenbaum, Thakor, and Boot
(2015) suggested three methods for the mitigation of regular liquidity demand: invests more funds in
the liquid loan, maintain more cash at hand and diversification of sources of funding. As a last resort,
central banks can also offer extra liquidity to meet the regular demand of liquidity. Since the chances
of error are there, to increase estimation accuracy, banks should carefully analyze client details, their
intention of deposit and withdrawal. The process regular liquidity demand estimation is so complex.
The hostile economic, financial and business environments are sometimes unpredictable. Therefore,
various proactive actions should be taken for this type of liquidity demand. For example,
development of a contingency plan, the combination of liquid assets and cash flows, allocation of
assets, bank organizational structure, and deposit policy of employees.

 Internal Control System for Liquidity Management:

To uphold the sturdiness of the liquidity management process, the banking organization need
to have an internal control system. It assists to meet the process carried out by the decision
supporters with the one given by the decision makers (BCBS, 2008). Internal control system for
liquidity management can be designated to the Asset Liability Committee (ALCO) as a consultant of
Board of Directors (BOD) to fill the distance between decision followers and decision makers.
Asset-liability committee (ALCO) analyze the liquidity risk level and decrease it according to the
guidelines and assessment provided by the Board of Directors (BOD) and decision markers for
required actions. Although, the standard and systematic works of the internal control system for
liquidity management are to extensively examine the liquidity management process. To assess the
liquidity position of the organization, and when needed to suggest and communicate modification in
the liquidity management process to the Board of Directors (BOD). Moreover, the organizations can
connect and cooperates with outside professionals such as government regulatory bodies to measure
the adequacy of a banking organization liquidity Risk-Management system and the degree of
liquidity of the institution.

2. Dependent variable (Bank financial performance):

The objective of the paper is to research the impact of risk and competition on the
profitableness of Pakistani banking system while controlling dominant, industry specific and
economic science variables. Four profitableness indicators internet interest margin ﴾NIM﴿, come on
assets ﴾ROA﴿, come on equity ﴾ROE﴿ and also the magnitude relation of profit before tax to total
assets ﴾PBT﴿ square measure square measure side red as dependent variables during this study.
 Profitability before tax to total assets:
Here, profitability margin is employed as a live of
profitability; it differentiates from ROA because it measures the profitability by excluding
taxes. The rationale for as well as this indicator is to check out the influence of taxes on the
gain of Pakistani banks. After we measured the profitability through profit margins, it
showed that the foreign banks have comparatively high profit margins than that of the state
closely-held, non-public and Islamic banks.

 Return on assets (ROA):

 This profitability quantitative relation shows banks’ ability to earn
profits through their total assets engaged within the business. It’s thought-about a key quantitative
relation for the activity of profitableness and wide employed in the empirical literature. This
quantitative relation helps to check the flexibility of the banks administration to utilize its
investment and monetary resources for earning profits. Whereas measuring the ROA of Pakistani
banks, demonstrates the foreign banks used their monetary resources in a very a lot of purposeful
approach as compared to alternative banks.
 Return on equity (ROE):
It represents the profitability of a bank that is generated through
the invested with quantity of its shareholders. Claimed that it's not an honest live of
profitability because it doesn't specialise in leverage risk. They support their claim by
conflict that banks typically with a better level of equity (low leverage) have higher ROA
however lower ROE. However, this indicator is very important to check as a result of it
reveals however well bank management is in exploitation shareholder’s funds. ROE helps
to live the potency of a bank for utilizing assets to cause earning growth.

 Determinants of Bank Performance:

There are various studies that were conducted to identify the main determinants of bank
performance, and different authors came with different conclusions. This implies that the
determinants of bank performance are many and they range from firm specific to macro
variables. In the study by Azam and Siddiqui (2011) the main determinants considered were
capital adequacy, credit risk, liquidity, deposit growth, Gross Domestic Product (GDP), and
inflation. For Sub Saharan Africa Flamini, mcdonald and Schumacher (2009) highlight credit
risk, capital size, market power, GDP and inflation as the main determinants of bank
profitability. In Saudi Arabia, Ahmed and Khababa (1999) are of the view that business risk,
market concentration, market size and size of the bank are the main determinants of bank
profitability.

 Bank Liquidity on Bank Performance:

There are a very limited number of studies that were specifically carried out to investigate
the impact of liquidity on bank performance. Surprising most of these few studies were done on
manufacturing companies. Therefore, most of the studies reviewed in this study were mainly
focused on finding determinants of bank profitability, of which liquidity was one of the
determinants of profitability. Some writers found a positive relationship; some found a negative
relationship while others found both results and a few found no relationship at all. The debate is
still rampant.

Bourke (1989) in his study on performance of banks in twelve countries in Europe, North
America and Australia found evidence that there is a positive relationship between liquid assets
and bank profitability. These results seem counterintuitive, as it is expected that illiquid assets
have a higher liquidity premium and hence higher return. Kosmidou, Tanna, and Pasiouras
(2005) realised that the ratio of liquid assets to customer and short term funding is positively
related to ROA and statistically significant. Also, they found a significant positive relationship
between liquidity and bank profits. Kosmidou (2008) examined the determinants of performance
of Greek banks during the period of EU financial integration (1990-2002) using an unbalanced
pooled time series data set of 23 banks and found that less liquid banks have lower ROA. This is
consistent with their previous findings like Bourke (1989) who found out that there is a positive
relationship between liquidity risk and bank profitability. Recently, Olagunju, David and Samuel
(2012) found out that there is a positive significant relationship between liquidity and
profitability. They concluded that there is a bi-directional relationship between liquidity and
profitability where the profitability in commercial banks is significantly influenced by liquidity
and vice-versa.

On the contrary, Molyneux and Thornton (1992) recognized that there is inverse
relationship between bank profitability and liquidity. They attributed this to the fact that banks
hold liquid assets as an obligation to the requirements imposed by the authorities. However, if the
author is to view this relationship from the context that banks hold liquid assets as mandated by
the central bank or any other authorities, then the author may miss the argument as banks also
hold liquid assets for other reasons. Assuming that banks only hold liquid assets as a requirement
is, in itself, perfidious or a deliberate ignorance of knowledge of how banks function. Tobin
(1958) advocated that liquidity is held for transaction purposes and for investments reasons.
Tobin’s proposal was a simplification of Keynes’ liquidity preference theory. Keynes (1936)
argued money is demanded for transaction, speculative, and precaution purposes. Therefore it
can be firmly said without any prejudice that liquid assets over and above mandatory
requirements are held for transaction, speculative and precautionary purpose.

Some authors found mixed results of both negative and positive relationship. Shen, Chen,
Kao, and Yeh (2010) assert that in market-based financial system liquidity risk is positively
related to net interest margin an indication that banks with high levels of illiquid assets receive
higher interest income. Conflicting to their earlier establishment on the relationship with net
interest margin, they realised that liquidity risk is negatively related to return on average assets
and also inversely related to return on average equity. They pointed out that banks incurred
higher funding cost in the market if they have illiquid assets as they had to raise the money in the
market to meet the funding gap. They also discovered that there is no relationship between
liquidity risk and performance in a bank- based financial system as the banks play a major role in
financing; therefore they are not affected by liquidity risk. Demirgüç-Kunt and Huizinga (1999)
had inconclusive results; they found a positive relationship between loans to total assets and the
net interest margins. They also established an inverse relationship between

the net interest margin and before tax profits. Ben Naceur and Kandil (2009) in their
analysis of cost of intermediation in the post- capital regulation period which included; higher
capital-to-assets ratios, an increase in management efficiency, an improvement of liquidity and a
reduction in inflation found out that Banks’ liquidity does not determine returns on assets or
equity significantly.

3. Empirical solutions:

3.1. Shukat, Awais and khursheed (2018) reported the“Impact of liquidity on

Profitability a Comprehensive Case of Pakistan’s Private Banking Sector”. This study is
quantitative explanatory study. The study used panel knowledge analysis of the variables
mentioned within the models. In this study, annual data (from 2014 to 2018) of twenty two
financial Pakistan are evaluated to evaluate the relationship between profitability and liquidity.
This analysis is evaluating the result of liquidity on profitableness by examining the monetary
knowledge of personal banking sectors of Islamic Republic of Pakistan by choosing twenty two
banks registered beneath state bank of Pakistan during the period Institutions from private
banking sector in Pakistan which are registered under state bank of during the period. It has been
suggested that the banks ought to evaluate andui rebuild their techniques for overseeing
liquidity. This won't just improve yields on investor’s value yet will likewise upgrade the
utilization of the resources of the bank.

3.2 Tanveer, sadaf, tahir, idress and M.asif (2019) reported the “Causative Impact of
Liquidity Management on Profitability of Banks in Pakistan: An Empirical Investigation”. The
study based on deductive approach and the Deductive is one which investigatorbuilds their studies
on hitherto existing theories on the foundation of which researcher develophypothesis that will be
tested later by empirical outcomes (Saunders, 2011). This study is explanatory in nature. This
study use quantitative method for research. . The unit of analysis the Pakistan banking sector-
covering period of 2009-2019 and data collected room annual reports and financial statements
from State bank of Pakistan publication and banks. The target population of this analysis is total
business banking sector of West Pakistan|West Pakistan|Asian country|Asian nation} and total
banks area unit 30in Pakistan that's used for draw the sample. The result demonstrates that ADR,
 CDR and DAR have positive impact on ROA, while negative impact on ROA.

3.3 Ahmad, Salam, Anwar and Ahmad (2018) reported that “The nexus between credit risk
and liquidity risk and their impact on banks financial performance: evidence from Pakistan”. The
sample information obtained from the annual issued money statements of thirty three banking
establishments operating in Pakistan covering from 2008-2018.Whereas the data on macro-
economic variables (GDP growth) were retrieved from World Bank Development Indicators. The
internal and external bank variables area unit treated instructive variables. The findings kind the
muse for recent regulative exertions to higher perceive the two sorts of risks and to strengthen the
joint management of each liquidity risk and credit risk.

3.4 Faluk, Firdos and Hussain (2018) investigate that “Impacts of risk and competition on
theprofitabilityofbanks”.
The purpose of the research is to find the impact of risk and competition on the profitability
of the Pakistani banks. Data are retrieved from the annual statements of banks, the Ministry of
finance Pakistan and the World Bank covering the period of (2008– 2018). The sample data focus
on the private, state-owned, Islamic and foreign banksworking in Pakistan since 2008. We selected
all 26 banks which were operating in Pakistanfrom2008–2018.The results of analysis tells that the
liquidity risk has positive whereas credit risk, financial condition risk and competition hurt
negatively the profitableness of Pakistani banking trade. The results of the study conjointly shows
that capitalization, size, taxation and GDP rate of growth completely have an effect on the Banks’
profits and banking sector development and infrastructure negatively have an effect on banking.

3.5 Olga, Michel and Ripsa reported that “The impact of liquidity risk on bank profitability:
some empirical evidence from the European banks”. The study determines the impact of liquidity on
bank profitability. This study supposed bundles of proxies of bank liquidity, including Liquidity
Coverage Ratio, Earnings before Taxes, Depreciation and Amortization are assumed to be alternative
proxies. In the research, a data collected from 45 European banks with 180 observations during
2014_2017 and 37 observations for 2018 has been analyzed. The study proposes a quantitative
model based mostly upon standard Least squires techniques complemented by weighted statistical
procedure regressions analysis. Findings: the choice liquidity risk measures have a big and positive
impact solely on some profit proxies, Associate in Nursingd an insignificant result on others. We
have a tendency to conjointly found mixed results regarding the consequences of deposits and
securities gains and losses on bank profits, and provided doable rationalization.

3.6 Dr.Mubarak (2020) reported thatthe Impact of liquidity risk management on financial
 performance of the Islamic banks in Egypt.
The purpose of this study is to investigate the efficacy of risk management practice that is
liquidity risk their impact on financial performance of Islamic banks. Liquidity risk is measured by
loan to deposit magnitude relation, money to total plus ratio. Money performance live
representations were come on assets (ROA) and come on Equity (ROE). Knowledge ar piece from
2013-2017 that is taken from the money reports of monotheism banks. Multivariate analysis has
been accustomed extract the results. The results of this study determined that however this
liquidity risk can have an effect on the bank money performance in Egyptian monotheism banks.

3.7 Salim and zaoug (2016) reported that the impact of liquidity management on financial
performance in Omani Banking Sector.This study aims to investigate the liquidity position and its
impact on the financial performance of Omani Banks with the eventual objective to advice policies
to improve the management of liquidity risk in Omani banks. A sample of 4 local commercial
banks has been used to examine the relationship between the Liquidity and Financial performance
for the period of five years from 2010-2014. The data has been taken from the Banks annual
reports using multiple regression analysis. The study concluded significant relationship between
the bank’s loans to total assets ratio, illiquid assets to liquid liabilities ratio and bank’s ROA;
bank’s Liquid assets/deposits; Liquid assets/Short term liabilities and ROE; and bank’s Loans/
Total assets, Loans/ Deposits & short term liabilities; Bank’s loans – customer deposits/ Total
assets and ROAA. However, The study finds no significant relationship between Omani bank
liquidity position (such as a bank high ability to absorb shocks, liquidity at short-term, ability to
cope with long term liquidity risk, less liquidity and less risk exposure) and NIM.

3.8 Ruziqa (2013) reported that the impact of credit and liquidity risk on bank financial
performance: the case of Indonesian Conventional Bank with total asset above 10 trillion Rupiah.
This paper examines the impact of credit and liquidity risk on bank’s financial performance.
This study especially focuses on Indonesian Conventional Bank with total asset above 10 trillion
Rupiah within 2007 to 2011. Bank financial performances are measured by return on asset, return on
equity and net interest margin; credit risk are measured by non-performing loan ratio and liquidity
risk are measured by liquidity ratio. Furthermore, this study also measured bank capital and bank
size’s effect on bank financial performance. The results show that credit risk has negative significant
effect on ROA and ROE. While liquidity ratio was found having positive significant effect on ROA
and ROE. The effect of bank capital is positively significant on ROA, ROE, and NIM, while bank
size was only found to have negative significant impact on NIM. Both credit risk and liquidity ratio
was found to have insignificant impact on NIM.
3.9 Maaka, Zaphaniah A (2013) reported that The relationship between liquidity risk
and financial performance of commercial banks in Kenya.Liquidity risk is considered as one of
the serious concern and challenge for the modern era banks. A bank having good asset quality,
strong earnings and sufficient capital may fail if it is not maintaining adequate liquidity.
Towards this end, the research sought to establish the relationship between liquidity risk and
financial performance of commercial banks in Kenya. The study adopted correlation research
design where data was retrieved from the balance sheets, income statements and notes of 33
Kenyan banks during 2008-2012. Multiple regressions was applied to assess the impact of
liquidity risk on banks’ profitability. The findings of the study were that profitability of the
commercial bank in Kenya is negatively affected due to increase in the liquidity gap and
leverage. With a significant liquidity gap, the banks may have to borrow from the repo market
even at a higher rate thereby pushing up the cost of banks. The level of customer deposit was
also found to positively affect the bank’s profitability and it will therefore be encouraged for
banks to open more branches in the country. The period studied in this paper is 2008-2012, due
to availability of the data. However, the sample period does not impair the findings since the
sample includes 14 banks, which constitute the main part of the Kenyan banking system. Only
profitability was considered in the study and there is need to consider other variables such as
the economic condition prevailing in a given period.

3.10 Noraini Mohd Ariffin (2012) reported that Liquidity Risk Management and
Financial Performance in Malaysia: Empirical Evidence From Islamic Banks.Abstract -
Liquidity risk arises from maturity mismatches where liabilities have a shorter tenor than
assets. A sudden rise in the borrowers‟ demands above the expected level can lead to shortages
of cash or liquid marketable assets (Oldfield and Santamero, 1997). This paper aims to analyse
the liquidity risks and disclosure as well as to draw the relationship between liquidity risks and
financial performance measures using return on assets (ROA) and return of equity (ROE) of
the Islamic banks. Based on selected Islamic banks in Malaysia over the period from 2006 to
2008, the study also attempts to determine the impact of the global financial crisis on the
Islamic banks‟ liquidity risks and financial performance. Findings of the study contribute
towards enriching the literature on the risk management of the Islamic banks by providing
deeper understanding on issues relating to liquidity risk management by the Islamic banks.
11. Liquidity Risk and Performance of Banking System in Malaysia
Posted: 29 May 2013
Last revised: 2 Oct 2017
Ameira Sohaimi
This paper aims to analyze the liquidity risks and disclosure as well as to draw the
relationship between liquidity risks and financial performance measures using deposits, cash,
liquidity gap and also non-performing loans as the indicator to the banking system in Malaysia
and evaluate the effect on banks’ capital and reserve. Data are retrieved from the utilizing
journals, books, Thompson Data Stream, balance sheet, income statements and report by Bank
Negara Malaysia for the period 1997-2012. Multiple regressions are applied to assess the
impact of liquidity risk on banks’ capital and reserve. The results of the multiple regressions
showed that liquidity risk affects banks capital and reserve significantly, with non-performing
loan (npls), as the exacerbating the liquidity risk. They have a negative relationship with
deposit, cash and liquidity gap. The period studied in this paper is one year, due to availability
of data. However, the sample period does not impair the findings since the sample includes 56
banks, which constitute the main part of the Malaysian banking system. Moreover, only npls
do not used to measure of performance. Economic factors contributing to liquidity risk are not
covered in this paper. This is paper are refer to journal who is research about the Pakistani
banking system but the result from that journal are not influence the result in this paper. This
paper helps in understanding the factors of liquidity risk and performance of banking system.
Consequently, understanding their impact on the bank’s capital and reserve of the banking
system.
12. The effect of liquidity risk management on financial performance of commercial
banks in Kenya Mwangi, Fredrick M
The aim of this study was to determine the effect of liquidity risk management on the
financial performance of Commercial Banks in Kenya. The study adopted a descriptive study
design. The population for this research is the 43 listed Commercial Banks in Kenya analyzed
for a period from 2010-2013.The results of the study show that a unit increase in liquid assets
to total assets ratio decreases return on assets by 1%. A unit increase in liquid assets to total
deposits ratio decreases return on assets by 2.2%. A unit increase in borrowings from banks
decreases return on assets by 14.2%. Finally the control variable which was asset quality
shows that a unit increase in non-performing loans as a proportion of total loans would lead to
a 12.4% decrease in return on assets.The study concludes that liquidity risk management has a
significant negative relationship with financial performance of commercial banks. Borrowings
from banks by commercial banks to meet shorter liquidity needs do have the greatest impact
on liquidity at 14.2% and was significant at 5%.The study also concludes that holding more
liquid assets as compared to total assets will lead to lower returns to commercial banks in
Kenya but the effect of not significant at 5%. Holding more liquid assets as compared to total
deposits will lead to lower returns to commercial banks in Kenya and the effect is significant at
5%.
13. The impact of liquidity risk management on the performance of Albanian
Commercial Banks during the period 2005-2015
This study is focused on liquidity risk analysis in order to identify if this risk affects the
profitability of Commercial Banks operating in Albania. The paper includes the identification,
the analysis and the management of this type of risk. Through numerical analysis it will be
studied the quantitative effect of liquidity risk on the profitability of commercial banks in
Albania during the period 2005-2015. Following the study, liquidity risk is expected to have a
considerable effect on the profitability of Commercial Banks operating in Albania. The
analysis is based on an empirical study with secondary qualitative and quantitative data. This
study provides a contribution within the identification of liquidity risk factors that affect more
the profitability of the Albania Banks and the finding of a scientific solution in order to
manage this risk in a more efficient way. The recommendations derived from this study will
serve to young researchers of academic area and professional field. Also, this paper will create
new discussions on risk management instruments used in the Albanian banking system.
14. Determinants of liquidity risk in Islamic banks
Tariq Alzoubi
This research analyzes the determinants of liquidity risk in Islamic banks by using a
comprehensive model that incorporates several variables that impact the liquidity of Islamic
banks. A panel data analysis is conducted on a sample of 42 Islamic banks from 15 countries
between 2007 and 2014. The results show a negative correlation between liquidity risk and
cash ratio, as the cash balance can be used to meet any demands for liquidity from the bank’s
customers. There is negative correlation between liquidity risk and securities held by the bank,
since banks which need liquidity can sell these assets to meet any liquidity shortages they face.
Bank size also has a negative relationship with liquidity risk, as larger banks tend to have more
stability and customers feel safer dealing with large banks. Bank’s equity also has a negative
correlation with liquidity risk, as equity is a more stable source of funding for banks, a higher
ratio of equity lowers liquidity risk. On the other hand, there is a positive relationship with
high profit assets, as banks shift their portfolio towards more profitable assets in order to
increase their earnings, they face greater liquidity risk, a positive relationship also exists with
bad finance provision. Additionally, the findings demonstrate that the relationship between
bank size and liquidity risk is not linear.
15. The Impact of Liquidity Risk on Banking Performance: Evidence from the
Emerging Market
M Saifullah Khalid, Md Rashed, Alamgir Hossain
Liquidity crisis is severe in Bangladesh commercial Banks and eventually some
commercial banks suffered due to higher default and liquidity problem. This paper aims to
empirically study the relationship between liquidity and financial performance of Commercial
banks in developing country like Bangladesh. The investigation has been performed using
panel data procedure for a sample of Dhaka stock market enlisted all commercial banks (31)
during the year of 2010-2017. Our result shows that liquidity has no significant and positive or
negative impact on return on asset (ROA), return on equity (ROE) as financial performance.
Liquidity risk behaves in equivalent ways in different dependent variables.
 16. Bank liquidity and financial performance: Evidence from Moroccan banking
industry
El Mehdi Ferrouhi 2014
This paper aims to analyze the relationship between liquidity risk and financial
performance of Moroccan banks and to define the determinants of bank’s performance in
Morocco during the period 2001–2012. We first evaluate Moroccan banks’ liquidity positions
through different liquidity and performance ratios then we apply a panel date regression to
identify determinants of Moroccan banks performance. We use 4 bank’s performance ratios, 6
liquidity ratios and we analyze 5 specific determinants and 5 macroeconomic determinants of
bank performance. Results show that Moroccan bank’s performance is mainly determined by 7
determinants: liquidity ratio, size of banks, logarithm of the total assets squared, external
funding to total liabilities, share of own bank’s capital of the bank’s total assets, foreign direct
investments, unemployment rate and the realization of the financial crisis variable.
17. Liquidity risk management and financial performance: are consumer goods
companies involved
SA Effiong, E Ejabu
The study examines the effect of liquidity risk management on the financial
performance of consumer goods companies. It was aimed at establishing the extent of concern
of consumer goods companies in the management of their liquid cash, cash defensive intervals,
long term debts, and quick ratios, for the purpose of turning around their financial
performance. Data were obtained from the annual reports and accounts of studied companies
and were converted to liquidity measurement parameters. Analyses were done using multiple
regression analysis methods and findings show that long term debts, quick ratios, and cash
defensive intervals have a significant effect on EPS and ROA, while cash ratio and long term
debts affect ROE only. Specifically, it was empirically established that there exists a
significant relationship between liquidity risk management and the financial performance of
consumer goods companies. Findings further reveal that companies’ non-concerned attitude to
liquidity risk management affects the financial performance of consumer goods companies
significantly. The study recommends that consumer goods companies should incorporate a
clear liquidity risk management approach in their strategic policy framework and communicate
the same to all functional units.
18. Liquidity and bank performance
Godfrey Marozva
This article relies on enquiry on the connection between liquidity and bank
performance for South African banks for the amount between 1998 and 2014. The study used
the Autoregressive Distributed Lag (ARDL)-bound testing approach and therefore the normal
statistical method (OLS) to look at the nexus between internet interest margin and liquidity.
Liquidity during this article is viewed within the context of the market liquidity risk and
funding liquidity risk. The study observes that there's a negative vital settled relationship
between internet interest margin and funding liquidity risk. However, there's Associate in
nursing insignificant co-integrating relationship between internet interest margin and therefore
the 2 measures of liquidity. Supported this analysis it's suggested that additional analysis ought
to be conducted to analyze liquidity within the context of asset-liability mismatches. Monetary
establishments conjointly ought to realise that liquidity may be a short-term development that
should be analysed in and of itself.

19. The Effect of Liquidity Risk on Financial Performance

Leonora Haliti Rudhani, Driton Balaj
This paper aims to review the impact of liquidity risk on the performance of banks in
Kosovo, for a amount of six years. The analysis is predicated on linear regression. Liquidity
risk indicators consult with the flexibility of the bank to soak up the liquidity shocks, L2-the
ability of the bank to deal with a high liquidity demand within the short term and L3-the ability
of the bank to face liquidity risk within the presence of non-liquid assets, whereas come back
on assets ROA and come back on equity ROE area unit the determinants of performance. The
results show that there's a positive and important relation between liquidity risk and
performance of the banks and complete that industrial banks in Kosovo may raise the extent of
performance by rising their ability to deal with the liquidity shocks risk, the short-run liquidity
risk and also the risk from the presence of enormous non-liquid assets.

20. The relationship between liquidity risk and credit risk in banks.
Björn Imbierowicz, Christian Rauch
This paper investigates the link between the 2 major sources of bank default risk:
liquidity risk and credit risk. We tend to use a sample of nearly all North American nation
industrial banks throughout the amount 1998–2010 to investigate the link between these 2 risk
sources on the bank institutional-level and the way this relationship influences banks’ chances
of default (PD). Our results show that each risk classes don't have associate economically
pregnant reciprocal contemporaneous or time-lagged relationship. However, they are doing
influence banks’ chance of default. This result is twofold: whereas each risks individually
increase the palladium, the influence of their interaction depends on the general level of bank
risk and might either worsen or mitigate default risk. These results offer new insights into the
understanding of bank risk associated function an underpinning for recent regulative efforts
aimed toward strengthening banks (joint) risk management of liquidity and credit risks.