The Effect of The Liquidity Management On Profitability in The Jordanian Commercial Banks
The Effect of The Liquidity Management On Profitability in The Jordanian Commercial Banks
The Effect of The Liquidity Management On Profitability in The Jordanian Commercial Banks
1; 2015
ISSN 1833-3850 E-ISSN 1833-8119
Published by Canadian Center of Science and Education
Received: October 30, 2014 Accepted: November 18, 2014 Online Published: December 20, 2014
doi:10.5539/ijbm.v10n1p62 URL: http://dx.doi.org/10.5539/ijbm.v10n1p62
Abstract
This research seeks to investigate the effect of the liquidity management on profitability in the Jordanian
commercial banks during the time period (2005–2012). Thirteen banks have been chosen to express on the whole
Jordanian commercial banks. The liquidity indicators are investment ratio, Quick ratio, capital ratio, net credit
facilities/ total assets and liquid assets ratio, while return on equity (ROE) and return on assets (ROA) were the
proxies for profitability. Augmented Dickey Fuller (ADF) stationary test model was used to test for a unit root in
a time series of the research variables and then testing hypothesis by using regression analysis. The empirical
results show that a positive effect of the increase in the quick ratio and the investment ratio of the available funds
on the profitability, while there is a negative effect of the capital ratio and the liquid assets ratio on the
profitability of the Jordanian commercial banks. The researcher recommends that there is a need for an optimum
utilization of the available liquidity in a various aspects of investment in order to increase the banks' profitability,
and banks should adopt a general framework of liquidity management to assure sufficient liquidity for executing
their operations efficiently, and they should initiate an analytical study of the evolution rates of liquidity and their
ability to achieve a balance between sources and uses of funds.
Keywords: liquidity, profitability, ROE, ROA, acid liquid assets
1. Introduction
The liquidity in the commercial bank represents the ability to fund its obligations by the contractor at the time of
maturity, which includes lending and investment commitments, withdrawals, deposits, and accrued liabilities
(Amengor, 2010).
Liquidity also means the ability to finance the increase in assets and meet liabilities when they due fall without
any unexpected losses, and so the efficient management of liquidity in the bank help to make sure that the bank
is able to meet the incurred cash, which are usually uncertain and subject to external factors and to the behavior
of other agents.
The liquidity management is a vital factor in business operations. For the very survival of business, the firm
should have requisite degree of liquidity. It should be neither excessive nor inadequate. Excessive liquidity
means accumulation of ideal funds. Which may lead to lower profitability, increase speculation, and unjustified
extension. Whereas inadequate liquidity result in interruptions of business operations. A proper balance between
these two extreme situations therefore should be maintained for efficient operation of business through skill full
liquidity management.
1.1 Research Problem
The commercial banks play their mediation role by absorbing financial surpluses from their holders (depositors)
and put them at the disposal of investors (borrowers) to be directed towards various investment channels. This
investment activity carried out by the bank is hardly devoid of risks and problems, because the bank is seeking to
maximize its expected profits on these investments, and this requires optimum utilization of the available
resources, since the bank is exposed at any moment to meet the obligations of its clients and depositors who
want to withdraw their savings, and so the bank should be ready to meet these demands at any time.
The problem arises when the Bank is not able to meet these demands, especially those unexpected ones, which
may embarrass the bank with its clients and may lose their trust over the time, in light of the intensive
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competition in the banking sector resulting from the increasing number of local banks, as well as intensive
competition from the foreign banks that work in the local banking market.
Therefore, each commercial bank should work to maximize its profits, and at the same time be able to meet the
financial requirements of its depositors by holding a sufficient amount of liquidity, in order to achieve a balance
between the profitability and liquidity. The problem lies in how to choose or select the optimal point or level at
which banks can maintain their assets in order to achieve these two objectives together, because each level of
liquidity has a different effect on the levels of profitability, and the problem arises when the commercial banks
try to maximize their profit at the expense of neglecting the liquidity, which may cause a technical and financial
hardship with the consequent withdraw of deposits. Therefore, this research seeks to answer the following
questions:
Does the efficient liquidity management affect profitability in the Jordanian commercial banks?
How do the liquidity indicators affect profitability in the Jordanian commercial banks?
What are the limitations that may hinder the achievement of the required balance between liquidity and
profitability, and how to overcome these limitations?
1.2 Research Objective
This research aims to examine the effect of the banking liquidity management on profitability in the Jordanian
commercial banks, considering their need to keep a highest balance between liquidity and profitability at the
same time. Therefore, this research will focus on identifying the most important indicators of the liquidity
management, investigate the effect of each indicator on the banks' profitability, identify the effect of the liquidity
management as a whole on profitability in the commercial banks, and lastly to suggest a recommendations
needed to achieve the required consensus between liquidity and profitability in these banks.
1.3 Research Design
The research is organized as follows: Section two presents an extensive review of literature on the effect of the
liquidity management on profitability in the commercial banks and the research hypotheses. Section three spells
out the methodological approaches used in this research. While Section four focuses on the analysis of the
research hypotheses, and to show the contribution of the research results in the provision of a new addition to
previous studies. Finally, section five reviews the findings and the recommendations reached by the researcher.
2. Literature Review
This section discusses some empirical and theoretical researches and publications about the effect of liquidity
management on the banks' profitability, and introduces an overview of Jordanian economy, and lastly presents
the study hypothesis.
2.1 Theoretical Literature
This part presents some theoretical aspects related to banks liquidity concept, the need for liquidity, theories of
liquidity management, banks profitability and its measures, as follows.
2.1.1 Banks Liquidity Concept
Bank liquidity means the ability to meet financial obligations as they come due. Liquidity in Commercial Bank
means the bank's ability to finance all its contractual obligations when due, and these obligations can include
lending, investment and withdrawal of deposits and maturity of liabilities, which happen in the normal course of
the Bank actions (Amengor, 2010).
2.1.2 Theories of Liquidity Management
There are a number of liquidity management theories, as follows:
1). Anticipated Income Theory
This theory states that the bank can manage its liquidity through the appropriate directing of the granted loans,
and the ability to collect these loans when due in a timely manner and to reduce the possibility of delays in
repayment at the maturity time.
This theory posts that bank's management can plan its liquidity based on the expected income of the borrower,
and this enables the bank to grant a medium and long-term loans, in addition to short-term loans as long as the
repayment of these loans are linked by the borrowers expected income to be paid in a periodic and regular
premiums, and that will enable the bank to provide high liquidity, when the cash inflows are regular and can be
expected.
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Where b1, b2, b3, b4, and b5: represents the coefficients values of the five independent variables of the second
model, respectively.
a0, b0: represent the values of the vertical section.
The model number (1) measures the effect of the liquidity management indicators on profitability in the
Jordanian commercial banks, where return on equity (ROE) was the proxy for profitability.
The model number (2) measures the effect of the liquidity management indicators on profitability in the
Jordanian commercial banks, where return on assets (ROA) was the proxy for profitability.
3.3 Research Variables Definition
The independent variables represent the liquidity management, which include the following measures (Ratios):
Investment ratio = Net credit facilities / Total deposits.
Net credit facilities / Total assets.
Capital ratio = Capital / Total assets
Liquid ratio = Acid liquid assets / Total assets.
Quick- Acid ratio = (Current assets- Inventory) / Current liabilities.
The independent variables: Represent the bank’s profitability measured by the return on equity (ROE), and
return on assets (ROA).
Investment ratio: This ratio indicates to the appropriateness of investing the available funds to the bank which
derived from deposits, to meet the demands of credited loans and advances. Investment ratio = Credit facilities /
Total deposits.
Net credit facilities / total assets. This percentage represents the bank's ability to exploit and employ the available
funds in achieving profits, and also indicates to the financial burdens that assist the banks in determining the
level of risk.
Capital Ratio. It is a measure of a bank's financial strength and the adequacy of its capital, and it indicates to the
extent of financial stability at the Bank.
Liquid ratio: This ratio measures the ratio of Acid liquid assets, which includes cash & equivalent and cash
reserve at the central bank, short-term deposits in banks and other government and non-government guaranteed
securities as a percentage of total bank assets.
Quick- Acid ratio: This ratio measures the bank's ability to repay short-term obligations during a very limited
period (a few days), and by comparing them with short-term assets in the same period. Quick- Acid ratio =
(Current assets- Inventory)/ current liabilities.
Return on equity: This ratio used as a measure of a corporation's profitability by revealing how much profit a
company generates with the money shareholders have invested. Return on Equity = Net Income/Owner's Equity.
Return on assets: This ratio is an indicator of how a bank is profitable relative to its total assets, and gives an idea
as to how a management is efficient in using its assets to generate earnings. ROA = Net Income/total assets.
3.4 Data Analysis
This research applies the quantitative, descriptive, ratios and econometrics analysis approaches in investigating
the effect of liquidity management on profitability in the Jordanian commercial banks during the time period
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(2005–2012), including the analysis of the profitability and liquidity ratios, Cross Sectional Analysis, regression
analysis, correlation analysis, and test (F-Fisher) analysis, which are being estimated by the least squares method
(OLS), through applying the statistical program (E-Views) on the panel data related to the indicators of liquidity
and profitability during the study period, based the annual reports issued by the Jordanian commercial banks, and
Amman Stock Market, and other relevant previous studies conducted on the banking profitability and liquidity in
Jordan and in other countries around the world.
3.5 Statistical Analysis and Interpretation
Unit Root Test Results (1st Model)
Stationary of the expletory variables and the dependent variable of the 1st model, was tested by using
Augmented Dickey Fuller (ADF) test.
Table 3 views the results which indicate the rejection of the unit root null hypothesis of the stationary of the
research variables at the first difference.
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means the two models used are appropriate, and there is a statistically significant effect of liquidity management
on profitability in the Jordanian commercial banks.
The total change in the dependent variable (ROE) demonstrated by the independent variables (R-squared) equals
to (0.76) which is statistically significant at the level of less than (0.05) where (Sig. R = 0.0000), and the value of
the determination coefficient (adjusted R- squared ) equals to (0.68).
The total change in the dependent variable (ROA) demonstrated by the independent variables (R-squared) equals
to (0.66) which is statistically significant at the level of less than (0.05) where (Sig. R = 0.0000), and the value of
the determination coefficient (adjusted R- squared ) equals to (0.56).
The correlation analysis test:
To examine the correlation between the dependent variables and the independent variables, we accept one of the
following hypotheses:
H0: There is no correlation between liquidity management and banks profitability.
H1: There is a correlation between liquidity management and banks profitability.
The decision rule as follow:
Accept H0 if (Sig. R) > 5%.
Accept H1 if (Sig. R) <5%
The analysis outputs show that the significant of the correlation value equals to (Sig. R = 0.0000), that there is a
statistically significant correlation between liquidity management and banks profitability.
The research hypotheses test:
The following two models used to investigate the effect of the independent variables on banks profitability, as
follows:
Y1 = a ± a1 (X1) ± a2 (X2) ± a3 (X3) ± a4 (X4) ± a5 (X5)
Y2 = b ± b1 (X1) ± b2 (X2) ± b3 (X3) ± b4 (X4) ± b5 (X5)
Test results of the research hypotheses:
The hypotheses test shows the results as follows:
1). There is a statistically significant positive effect of the investment ratio on profitability of the Jordanian
commercial banks.
2). There is a statistically significant negative effect of the credit facilities divided by the total assets on
profitability of the Jordanian commercial banks.
3). There is a statistically significant negative effect of the capital ratio on profitability of the Jordanian
commercial banks, when the profitability measured by ROE, but this effect becomes positive when using ROA
as a proxy for profitability.
4). There is a statistically significant negative effect of the liquid ratio on profitability of the Jordanian
commercial banks.
5). There is a statistically significant positive effect of the quick ratio on profitability of the Jordanian
commercial banks.
To examine the total variation in the dependent variable explained by the independent variables, we accept one
of the following hypotheses:
Ho: Ho: There is no statistically significant effect of liquidity management on the profitability of the Jordanian
commercial banks.
H1: There is a statistically significant effect of liquidity management on the profitability of the Jordanian
commercial banks.
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