ADDIS ABABA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

FACTORS AFFECTING LIQUIDITY OF COMMERCIAL BANKS: (CASE

STUDY ON SELECTED BANKS IN ETHIOPIA)

BY:
DESIBELEWE ERKIHUNE

A THESIS SUBMITTED TO THE DEPARTMENT OF ACCOUNTING

AND FINANCE FOR PARTIAL FULFILLMENT OF THE REQUIRMENT
OF MASTERS OF ACCOUNTING AND FINANCE

ADVISOR:

Dr. ABEBE Y.

AUGUST 2023

ADDIS ABABA, ETHIOPIA

 DECLARATION

I, Desibelew Erkihune declare that this thesis is my original work, prepared under the guidance
of Dr, Abebe Yitayew. I prepared, collected, analyzed and finished this thesis in accordance
with all the scholarly ethical standards. All academic information used in this thesis has been
acknowledged through citations. Additionally, I affirm that I have followed all rules governing
academic honesty and integrity and that I have not created or manipulated any ideas or data in
my work. This thesis is being submitted in partial fulfilment of Addis Ababa University's Master
of accounting and finance requirement. I further confirm that this thesis has not been submitted
either in part or in full to any other higher learning institution for the purpose of earning any
degree.

Declared by:

Name: Desibelew Erkihune

Signature _______________

Date: ____________________
 Statement of Certification
This is to certify that this study, ―Factors affecting liquidity of commercial Banks, (case study on
selected banks in Ethiopia)‖, undertaken by Desibelew Erkihune for the partial fulfillment of
Masters of accounting and finance at Addis Ababa University, is an original work and not
submitted earlier for any degree either at this University or any other University, and has been
supervised in accordance with university policies, and the student has my permission to submit it
for evaluation.

Research Advisor: Dr.Abebe Yitayew

Signature ______________________________________

Date__________________________________________
 Factors Affecting Liquidity of Commercial Banks: (Case Study on Selected

Banks in Ethiopia)

By: Desibelew Erkihune

Approval Sheet

As members of the Board of Examining for the Final master of accounting and finance thesis
Defiance, we certify that we have read and assessed the study prepared by Desibelew Erkihune
entitled Factors affecting liquidity of commercial Banks, (case study on selected banks in
Ethiopia)‖, and we recommend that the thesis be accepted as satisfying the requirement for the
Degree of Master of Art in Accounting and Finance.

Thesis Approved by:

Internal Examiner Signature Date

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 Acknowledgement
First of all, I would like to thanks the Almighty God for letting everything to happen in better
way. Then I would like to give my honorable thanks to the department as a whole for giving the
opportunity to prepare this thesis.

I would like to recognize the invaluable assistance of my advisor Dr. Abebe Yitayew for his
unlimited support and motivation beside his friendly and professional approach and advice.

Finally, I am very grateful to my family and friends for their encouragement, endless support and
appreciations.

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Acronym
AB: Awash Bank S.C.

AS: Asset Management

BIS: Bank of International settlement

BOA: Bank of Abyssinia S.C.

BS: Bank size

CAP: Capital Adequacy

CBO: cooperative bank of oromia

CLRM: Classical Linear Regression Model

DB: Dashen Bank S.C.

DG: Deposit Growth

DW: Durbin-Watson

FEM: Fixed Effect Model

GDP: Gross Domestic Product

GFC: Global Financial Crisis

LC: Liquidity creation

LIQ: Liquidity

LIB: Lion international Bank S.C.

OIB: Oromia International Bank S.C.

OPEF: Operational efficiency

OLS: Ordinary Least Square

NBE: National Bank of Ethiopia

NBE –bills purchase: national bank bills purchase

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NIB: Nib International Bank S.C.

NPL: Non-performing loans

REM: Random Effect Model

RR: Reserve Requirement

ROA: Return on Assets

RR: Reserve Requirement

HB: Hibret Bank S.C.

WB: Wegagen Bank S.C.

ZB: Zemen Bank S.C.

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 Abstract
The main objective of the study is to investigate the factors that affect Ethiopian commercial
bank’s liquidity. The data covered the period from 2018-2022 G.C for the sample of selected ten
commercial banks. Quantitative research approach and explanatory Research design were
adopted in carrying out this research. Secondary data were collected from the selected ten
commercial banks using purposive sampling technique. Macro- economic data are collected
from NBE and World Bank report while internal factor data were collected from audited
financial statements. The study used both descriptive and inferential statistics. Mean and
standard deviation were used as descriptive statistics, whereas correlation and panel regressions
were used from inferential statistics using stata. The findings of the study shows that bank size,
gross domestic product, and national bank bill purchase have negative and statistically
significant impact on liquidity and profitability has positive significant effect on commercial
banks liquidity. Deposit growth, reserve requirement and asset management have positive and
statistically insignificant impact on liquidity. In addition, Capital adequacy and operational
efficiency have negative insignificant effect on bank liquidity. The study suggests that focusing
and reengineering the banks alongside the key internal factors could enhance the liquidity
position of the commercial banks in Ethiopia. Moreover, banks in Ethiopia should not only be
concerned about internal structures and policies, but they must consider the macroeconomic
environment together in developing strategies to improve the liquidity position of the banks. On
the other side the policy maker, NBE has to consider the existing economic conditions and
promote favorable environment to the development of the financial sector.

Keywords: Ethiopian banks; liquidity ratio; internal factors; external factors; OLS model; linear
regression.

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 Table Contents
Acknowledgement ........................................................................................................................... i

Acronym ......................................................................................................................................... ii

Abstract .......................................................................................................................................... iv

List of Table ................................................................................................................................... ix

Table of Figure ................................................................................................................................ x

CHAPTER ONE ............................................................................................................................. 1

INTRODUCTION ....................................................................................................................... 1

1.1 .Background of the Study ................................................................................................. 1

1.2. Statement of the Problem ................................................................................................. 4

1.3. Research Questions .......................................................................................................... 6

1.4. Objectives of the Study .................................................................................................... 7

1.4.1. General Objective ..................................................................................................... 7

1.4.2. Specific Objectives, .................................................................................................. 7

1.5. Hypothesis ........................................................................................................................ 7

1.6. Significance of the Study ..................................................................................................... 8

1.7. Scope of the Study................................................................................................................ 8

1.8. Limitation of the Study ........................................................................................................ 8

1.9. Organization of the Paper ..................................................................................................... 9

CHAPTER TWO .......................................................................................................................... 10

LITERATURE REVIEW ............................................................................................................. 10

2.1 . INTRODUCTION ........................................................................................................ 10

2.2. Theoretical Review ............................................................................................................ 10

2.2.1. Definition and Function of Commercial Banks ........................................................... 10

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 2.2.2. Bank Liquidity Creation -Theory ................................................................................ 11

2.2.3. Keynes Motives of Money Theory .............................................................................. 13

2.2.4. Bank Liquidity Creation and Financial Fragility-Theory ............................................ 13

2.3. Internal Factors Affecting Bank Liquidity ..................................................................... 14

2.3.1. Bank Size and Bank Liquidity ..................................................................................... 14

2.3.2. Capital Adequacy and Bank Liquidity ........................................................................ 15

2.3.3. Profitability and Bank Liquidity .................................................................................. 16

2.3.4. Asset Management ...................................................................................................... 16

2.3.5 ....................................................................................................................................... 17

2.3.6. Deposit Growth and Bank Liquidity ........................................................................... 18

2.4. Macroeconomic Factors Affecting Liquidity ..................................................................... 18

2.4.1. Gross Domestic Products (GDP) .................................................................................... 18

2.4.2. Reserve Requirement ................................................................................................... 19

2.4.3. NBE-bills Purchase and Bank Liquidity ..................................................................... 19

2.5. Empirical Review ............................................................................................................... 20

2.5.1. Empirical Review of International Studies .................................................................. 20

2.5.2. Related Ethiopian Empirical Studies on Liquidity ...................................................... 22

2.6. Conclusion and Knowledge Gap ........................................................................................ 24

2.7. Conceptual Framework ...................................................................................................... 25

RESEARCH METHODOLOGY AND DESIGN ........................................................................ 26

3.1. Introduction ........................................................................................................................ 26

3.2. Research Design ................................................................................................................. 26

3.3. Research Approach ............................................................................................................ 27

3.4. Population and Sampling Frame ....................................................................................... 28

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 3.5. Sampling Technique ........................................................................................................... 29

3.6. Sample Size ........................................................................................................................ 29

3.7. Data Source and Collection Instrument ............................................................................. 29

3.8. Study Variables Description............................................................................................... 30

3.8.1. Dependent Variable ..................................................................................................... 30

3.9. Independent Variables ........................................................................................................ 31

3.10. Ethical Consideration ....................................................................................................... 35

3.11. Model Specification ......................................................................................................... 36

3.12. Data Analysis Methods .................................................................................................... 37

3.13. Data Presentation.............................................................................................................. 38

CHAPTER FOUR ......................................................................................................................... 39

DATA PRESENTATION AND ANALYSIS .............................................................................. 39

4.1. Summary of Descriptive Statistics. .................................................................................... 39

4.2. Correlation Analysis ........................................................................................................... 41

4.3. Diagnostic tests of the of Classical Linear Regression Model (CLRM) ............................ 43

4.3.1. Heteroskedasticity Test................................................................................................ 43

4.3.2. Test of Normality......................................................................................................... 45

4.3.3. Multicolinearity Test ................................................................................................... 46

4.3.4 .Test for Autocorrelation .............................................................................................. 47

4.3.5. Test for Model Specification: Ramsey RESET Tests ................................................. 48

4.3.6. Random Effect vs. Fixed Effect Models ..................................................................... 49

4.3. Regression Analysis and Interpretation.............................................................................. 51

4.3.1. Interpretation of F- Statistic/variance Test/Model fit test ........................................... 52

4.3.2. Interpretation of Coefficient of Determination(R- squared)........................................ 53

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 4.3.3. Interpretation of Adjusted R – Squared ....................................................................... 53

4.3.4. Interpretation of Regression Result ............................................................................. 53

4.3.5. Interpretation of Intercept (Constant) .......................................................................... 54

4.4. Discussion of Regression Results ...................................................................................... 54

4.4.1. Interpretation of Bank Size .......................................................................................... 54

4.4.2. Interpretation of Capital Adequacy Ratio .................................................................... 54

4.4.3. Interpretation of Profitability Ratio ............................................................................. 55

4.4.4. Interpretation of Asset Management ........................................................................... 55

4.4.5. Interpretation of Operational Efficiency...................................................................... 55

4.4.6. Interpretation of Deposit Growth ................................................................................ 56

4.4.7. Interpretation of Gross Domestic Product ................................................................... 56

4.4.8. Interpretation Reserve Requirement ............................................................................ 56

4.4.9. Interpretation of National Bank bill and Liquidity ...................................................... 57

4.5. Summary of Analysis ......................................................................................................... 58

CHAPTER FIVE .......................................................................................................................... 59

SUMMARY OF FINDINGS, CONCLUSION, AND RECOMMANDATIONS........................ 59

5.1. Introduction ............................................................................................................................ 59

5.2. Summary of Findings ............................................................................................................. 59

5.3. Conclusion ............................................................................................................................. 61

5.4. Recommendations .............................................................................................................. 61

5.5. Suggestion for Future Study............................................................................................... 63

References ..................................................................................................................................... 64

APPENDEX 1............................................................................................................................... 70

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 List of Table
Table 1 Sample Banks .................................................................................................................. 28
Table 2 summary of explanatory variables and their anticipated effects ...................................... 35
Table 3 descriptive statistics of dependent and independent variables......................................... 39
Table 4 Correlation Analysis ........................................................................................................ 42
Table 5 Heteroscedasticity Test .................................................................................................... 44
Table 6 Test of normality.............................................................................................................. 46
Table 7. Multi-collinearity test by variance inflation factor ......................................................... 47
Table 8.Test for Autocorrelation................................................................................................... 48
Table 9.Test for Model Specification: Ramsey RESET Tests ...................................................... 49
Table 10.Breusch and Pagan Lagrangian multiplier test for random effects ................................ 51
Table 11 summary of analysis ...................................................................................................... 58

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 Table of Figure
Figure1.Relationship between liquidity and its determinants……………………………….....26

Figure 2.Test of Heteroskedasticity by White test………………………………………………45

Figure 3.Random effect vs. fixed effect model models ................................................................ 50

Figure 4.Regression result by OLS ............................................................................................... 52

x
 CHAPTER ONE

INTRODUCTION

1.1.Background of the Study

A bank is a type of financial organization that is authorized to accept deposits and offer loans. In
addition, banks might provide financial services like asset management, currency exchange, and
safe deposit lockers (Adam Barone et, at, 2023). The different sorts of banks include retail banks,
commercial or corporate banks, and investment banks, to name a few. In the vast majority of
countries, banks are governed by the national government or central bank (Barone, 2023). A
"commercial bank" is a type of financial organization that accepts deposits, offers checking
account services, makes various loans, and offers basic financial products including certificates
of deposit (CDs) and savings accounts to individuals and small businesses (Julia Kagan, et al
2023). Banks are essential to economic development because they serve as a bridge to encourage
investment and growth (Thomas Lambert et, al 2020). The mid-2007 to early-2009 era of high
stress in the world's banking institutions and financial markets is referred to as the global
financial crisis (GFC). During the Global Financial Crisis (GFC), a decline in the US housing
market served as the motivation for a financial crisis that expanded from the US to the rest of the
globe via connections in the global financial system (Cernohorský et al 2010). Many banks
suffered significant losses and needed assistance from the government to stay afloat. As the main
industrialized economies endured their biggest recessions since the Great Depression in the
1930s, millions of people lost their employment. In comparison to previous recessions without a
financial crisis, the recovery from this one happened far more slowly. Why are commercial
banks concerned about liquidity? The operations of commercial banks depend greatly on
liquidity. A bank with high liquidity has greater access to capital, which opens up a variety of
lending and investing opportunities.
During the global financial crisis, many banks found it difficult to keep enough liquidity.
Unprecedented levels of liquidity support from central banks were needed to maintain the
financial system (Cernohorský, J, Teplý P and Vrabel, 2010). Despite receiving such a lot of

1
assistance, a number of banks failed, were forced into mergers, or needed resolution (Teplý,
2011). The crisis highlighted the significance of accurate measurement and management of
liquidity risk. The speed at which you can access your money is referred to as liquidity.
Liquidity is the ability to access your money whenever you need it. It is the effectiveness or
simplicity with which an asset or security can be turned into immediate cash without impacting
its market price (Adam Hayes 2023). It is an indicator of the amount of cash and other resources
banks have at their disposal to promptly settle accounts and take care of pressing commercial
and financial commitments. Cash alone is the most liquid asset. For a bank, liquidity is the
capacity to pay its debts as they become due without suffering intolerable losses (BIS., 2008).
Liquidity risk consequently results from banks' basic involvement in the maturity
transformation of short-term deposits into long-term loans. It comprises two different kinds of
risk: market and funding liquidity risks. Funding liquidity risk is the possibility that a business
won't be able to pay its short-term debts when they're due. The danger that a business won't be
able to pay its present outstanding debts is known as funding liquidity risk. Market liquidity risk
is the loss a market player faces when they wish to execute a trade or liquidate a position right
away but don't get the best deal. Liquidity position of banks can be affected by bank specific
factors (bank size, non-performing loans, asset management, Deposit Growth profitability and
operational efficiency) and macroeconomic factors (Reserve Requirement), Inflation rate, NBE
Treasury bill purchase, and real Gross Domestic Growth (GDP)).

In other words, liquidity is the capacity of a financial institution to meet all lawful requests for
funds. According to Aspachs et. al, ( 2005) banks must maintain the ideal amount of liquidity to
maximize their profit and allow them to fulfill their obligations. However, as was noted by
(Diamond an (Diamond and Dybvig,, 1983), one of the main reasons why banks are fragile is
their role in altering maturity and providing insurance with regard to depositors' possible
liquidity needs. Generally speaking, banks work to balance profitability and liquidity (Niresh,
2012). A crucial aspect of banking is ensuring that consumers always have access to enough
liquidity. In order to meet withdrawal requirements and new loan demand from clients in need of
liquidity, banks make sure that there is a sufficient supply of cash and other near-cash securities
accessible.

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In Ethiopia context to the knowledge of the researcher, there are more than three works on the
title factors affecting liquidity in commercial banks in Ethiopia. Of these researches one is
conducted by, (Belete, 2015). According to Belet, Liquidity for a bank means the ability to meet
its financial obligations as they come due, without incurring unacceptable losses. The study
conducted by him examined, factors affecting liquidity in selected private commercial banks in
Ethiopia, by adopting mixed approach, a quantitative approach and qualitative approach. The
researcher overlooked some important variables that can significantly affect Ethiopian
commercial banks‘ liquidity.

However, factors such as operational efficiency of the bank, bank service quality, and the level
of asset management that are crucial to bank liquidity were left out of the study. One more is a
study conducted by (Teshome, 2017). According to Teshome , liquidity as the ability of a bank
to fund increases in assets and meet obligations as they come due, without incurring
unacceptable losses. The study, which focused primarily on a few key variables like GDP,
Government policy, bank size, etc. that can significantly affect Ethiopian banks' liquidity, was
undertaken by him and studied the determinants affecting liquidity in a few selected private
commercial banks in Ethiopia. Additionally, a study by (Rahel, 2019), stated that Liquidity
creation is the main concerns of commercial banks because banks are mainly involved in deposit
mobilizing and lending which have direct impact on their liquidity. The study focuses on factors
affecting liquidity in a sample of private commercial banks in Ethiopia using data gathered
between 2000 and 2017 G.C. The purpose of this study is to look at the effect of factors affecting
liquidity in selected commercial banks of Ethiopia by capturing bank specific factors (bank size,
capital adequacy, non-performing loans, asset management profitability, deposit growth and
operational efficiency) and macroeconomic factors (Reserve Requirement, Inflation rate,
National Bank bill purchase, and real Gross Domestic Growth (GDP)).

3
1.2. Statement of the Problem
The primary function of a bank is to move money from surplus to deficit economic units.
Furthermore, they give policy makers a way to implement monetary policies that maintain price
and foreign exchange stability. However, the bank's operations are not without problem because
they play a crucial role in the maturity transformation of short-term deposits into long-term
loans, which are naturally subject to liquidity risk (shumet, 2016). Under such conditions, banks
will be exposed to liquidity issues, which could irritate their clients and have an impact on the
entire financial industry. Alternatively, when banks maintain excessive amounts of liquid assets
that don't pay interest, including cash and non-interest bearing deposits, Profitability at the bank
will be affected. Every bank must therefore ensure that it operates to meet both its profitability
aim and the financial needs of its clienteles by maintaining an ideal level of liquidity (Mesfin
AberaYednke, 2022).

A liquidity problem starts with widespread maturity mismatches across banks and other firms,
which leaves them short on cash and other liquid assets when they're needed. Large, detrimental
economic shocks or typical economic cyclical shifts can both lead to liquidity problems. The
amount of cash and other assets that banks have on hand to promptly settle accounts and take
care of urgent business and financial commitments is known as liquidity. Cash and other assets
that may be quickly turned into cash are known as liquid assets and are used to satisfy financial
obligations. Central bank reserves and government bonds are also typical examples of liquid
assets (Chen, 2022). A financial institution must have sufficient liquid assets to cover depositor
withdrawals and other short-term obligations in order to continue operating. Banks exposed the
danger of not having enough liquid assets to meet random requests from depositors (Gatev,
2007),Since, bank liabilities often have shorter maturities than bank assets; as a result, banks
must continuously manage funding of their balance sheet structure based on maturity
transformation. For the reason banks are inevitably exposed to liquidity risk when they engage in
a cycle of continuously re-financing (Bonfim & Kim, 2012)

Banks operational risk is influenced by liquidity since it has a significant impact on the
operational activities that banks carry out (Fielding, D and Shortland, , 2005). A lack of cash or
assets that can be quickly converted into cash across numerous businesses or financial
institutions at once is a sign of a liquidity risk. A severe rise in demand and a sharp decline in

4
availability of cash occur during a liquidity crisis, and the resulting lack of accessible
liquidity can result in widespread defaults and even bankruptcy. In order to improve their
business operations, borrowers are currently concerned about the liquidity problem in Ethiopia,
in addition to banks and regulatory bodies. Customers' deposits are used to fund the loans made
by banks. To meet the demand of the investors, however, Ethiopian banks hardly ever find those
cash. Few studies on the factors influencing bank liquidity in Ethiopia have recently been
conducted in an effort to pinpoint the variables that influence the liquidity of commercial banks
in Ethiopia. Among the researchers involved in the field were:

Tseganesh (2012), analyzed both bank specific and macroeconomic variables from year 2000 to
2011 for the sampled commercial banks and the result was, capital adequacy and loan growth
have positive and insignificant relationship with liquidity and on the contrary NPL, GDP and
INF have negative and insignificant relationship and finally bank size IRM, STIR have negative
and significant relationship to banks liquidity. However, the study didn‘t include the effect of
bank specific factor like operation efficiency and Asset management.

Belete (2015), Uses balanced fixed effect panel regression to investigate the bank-specific and
macroeconomic determinants affecting bank liquidity for eight commercial banks in Ethiopia
over the period of 2002–2013. In order to achieve this, the study used a mixed-methods approach
that combines documentary analysis and in-depth interviews. The study's conclusions
demonstrate a statistically significant and favorable association between capital adequacy,
interest rate margin, and inflation and banks' liquidity. On the other hand, the association
between loan growth and bank liquidity was negative and statistically significant. However, it
was discovered that the correlation between profitability, non-performing loans, bank size, and
the GDP was statistically negligible. According to the study, strengthening the focus and
reengineering of the banks as well as the important internal drivers could improve the liquidity
position of Ethiopia's commercial banks. The impact of bank-specific characteristics, such as
asset management and operational efficiency, was left out of the study.

Rahel (2019), investigates the macroeconomic, industry-specific, and bank-specific variables that
influence the liquidity of Ethiopian commercial banks. For the sample of six private commercial
banks that were carefully chosen, the data covers the years 2000 to 2017. This study was
conducted using a quantitative research methodology and an explanatory design. Purposive

5
sampling was used to gather secondary data from the six private commercial banks that had been
chosen. The study's conclusions indicate that factors such as bank size, capital adequacy ratio,
reserve requirement, interest rate spread, loan growth, and NBE bill purchasing have a negative
and statistically significant impact on liquidity. The impact of bank-specific factors, like asset
management and operational efficiency, was left out of the study.

The trend in the liquidity ratio of Ethiopian commercial banks also decreased from time to time
so far (Belete et al 2015). Therefore, to identify what make banks illiquidity is important to
bankers and regulators to protect banks from liquidity shocks. This liquidity problem can be
aggravated by different factors which are internal and external or bank specific and
macroeconomic factors. Under such basic factors there are different specific factors affecting
bank liquidity in the context of Ethiopia. Even though different researchers mentioned different
specific factors that affect commercial banks liquidity, there are also other factors that are not
included in their study like operation efficiency of the bank, Service quality of the bank asset
quality of the bank and Asset management that plays great role in determination of commercial
banks liquidity. Generally neither of the aforementioned researcher nor the others in Ethiopia
used the above bank specific factors (Operational efficiency and Asset management) in Ethiopia.
Lack of uniform literature and detail explanation about the effect of GDP, Inflation rate and bank
size that includes the above mentioned factors in the area leads to the researcher to conduct this
research and knowing about such factors are crucial for better understanding of liquidity issues
for both regulatory bodies and financial institutions. The existence of such knowledge gap in the
area initiated to do this study. Therefore, this study seeks to fill the gap by providing additional
internal factors that affects Ethiopian commercial banks liquidity.

1.3. Research Questions

Based on the problem stated in this study, the researcher develops the following research
questions.

1. What are the internal/Bank specific/ factors that affect bank liquidity in commercial
banks of Ethiopia?
2. What are the macroeconomic/external/ factors that affect bank liquidity in commercial
banks of Ethiopia?

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1.4. Objectives of the Study
Banks liquidity problem can be affected by two major factors in which the study focuses, i.e.,
bank specific or industry specific and macroeconomic factors on Ethiopian selected commercial
banks. In the problems highlighted above, the study has the following general and specific
objectives.

1.4.1. General Objective

The general objective of the study is,

 To investigate the factors that affects bank liquidity in selected commercial banks of
Ethiopian.

1.4.2. Specific Objectives,

 To identify the external factors that affects banks liquidity in selected Ethiopian
commercial banks.
 To describe the internal factors that influences banks liquidity in selected Ethiopian
commercial banks.

1.5. Hypothesis
In order to attain the above general and specific objectives the following hypothesis are
formulated,

H1: bank size has negative and significant effect on bank‘s liquidity problem.
H2: Capital adequacy has positive and significant effect on bank liquidity
H3: profitability has positive and significant impact on bank‘s liquidity.
H4: Asset management has a positive insignificance impact on banks liquidity.
H5: There is a Negative and insignificant relationship between operation efficiency of the
bank and banks liquidity.
H6: Deposit growth has positive and significant relation with bank liquidity.
H7: Gross domestic product has positive/negative significant impact on banks liquidity.
H8: Reserve requirement has negative significant impact on bank‘s liquidity.
H9: There is a negatively significant relationship between the NBE-Bill purchase and
banks liquidity.

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 1.6. Significance of the Study
V.I.J. Kumar (2008) Due to inadequate liquidity management, banks all around the world are
currently experiencing liquidity problems. Managing liquidity risks is crucial since every
commitment or transaction has an influence on a bank's liquidity.
One of the most significant components of the framework for enterprise-wide risk management
is liquidity risk. A bank's liquidity system should retain enough liquidity to survive all potential
stress scenarios. The correct operation of the bank will be ensured by a thorough examination of
the bank's liquidity risk management system and liquidity situation. Although some studies
conducted in the area of factors affecting bank liquidity in Ethiopia this study would also have a
great contribution to the existing knowledge in the areas of factors affecting commercial banks
liquidity in Ethiopia.
 The outcomes and results of this thesis will have potential value to financial
institutions, particularly banks to understand banks liquidity.
 It will serve as a reference material for both academicians and practitioners
 It will initiate the concerned organization to assess the existing practice of
liquidity and liquidity risk management.
 It will initiate other interested researchers to carry out more studies extensively
in the area of bank liquidity problem.

1.7. Scope of the Study

The scope of the study focused on factors affecting liquidity in selected Commercial Banks of
Ethiopia. Considering time and financial constraints the study chooses a sample of ten
commercial banks functioning in Ethiopia that have a data to the minimum five years. These
banks are AB, DB, BOA, CBO, ZB, OIB, NIB, WB, LIB and HB.

1.8. Limitation of the Study

This study was designed to examine the factors affecting liquidity of commercial banks in
Ethiopia by using quantitative approach with secondary data due to time, resources as well as
availability of data constraint. Since the study only focused on a sample of ten selected
commercial banks due to the lack of availability of data and governmental intervention, it was
very difficult to include all commercial banks that are found in Ethiopia. The study would be

8
better generalized; if one could include all commercial banks to explain the factors affecting
liquidity of Ethiopian commercial banks.

1.9. Organization of the Paper

This research paper has five chapters. Chapter one presents the introduction part, which contains
background of the study, statement of the problem, research questions, objectives of the study,
hypothesis, scope of the study, limitations of the study, Significance of the research paper and
Organization of the paper. Chapter two was presents literature reviews both theoretical and
empirical view regarding factors affecting banks liquidity in commercial bank of Ethiopia.
Chapter three was presents research methodology which would be adopted in the research. The
research results and discussion were presented in the fourth chapter. The summary of findings,
conclusion and recommendations were presented in chapter five.

9
 CHAPTER TWO

LITERATURE REVIEW

2.1. INTRODUCTION
In chapter two the answer of all the questions which are raised in the study about factors
affecting liquidity in commercial banks of Ethiopia discussed. Commercial banks comprise
public sector banks, foreign banks private sector banks that are financial institutions which
perform the function of accepting deposits from the general public and giving loans for
investment for the aim of generating profit. In related to these function commercial banks may
face a problem called liquidity. Liquidity refers to the efficiency or ease with which an asset or
security can be converted in to ready cash without affecting its market value. Liquidity can be
affected by internal as well as external factors. In the first section of chapter two, the paper
discusses a theoretical review of the variables affecting the liquidity of Ethiopian commercial
banks. Different theories regarding what influences bank liquidity are offered in more detail then
various empirical studies carried out by researchers are described in a condensed manner.
Additionally, the study's conceptual framework and reason for the research effort were discussed.
Finally, conclusions about the review of the literature and knowledge gaps are presented.

2.2. Theoretical Review

2.2.1. Definition and Function of Commercial Banks

A financial institution with permission to accept deposits and issue loans is referred to as a
bank. In addition to lending money, banks may also offer other financial services including safe
deposit boxes and wealth management. Retail banks, corporate or commercial banks, and
investment banks are just a few examples of the numerous types of banks. Most nations have a
national government or central bank that controls the banking industry (Barone, 2023)
Commercial bank refers to a financial institution that accepts deposits, offers checking
account services, makes various loans, and offers basic financial products like certificates of
deposit (CDs) and savings accounts to individuals and small businesses. A commercial bank is
where most people do their banking (Julia, 2016). The functions of commercial banks are
classified into two main divisions. Accepts deposit, Provides loan and advances, Credit

10
cash, Discounting bills of exchange, Overdraft facility: Purchasing and selling of the securities,
Locker facilities, Paying and gathering the credit

However, the activity of the bank is not without problems, since banks have fundamental role in
the maturity transformation of short-term deposits into long-term loans that inherently exposed
for liquidity risk. Liquidity risk is the risk that a company or individual will not have enough
cash to meet its financial obligation or pay its debit. Liquidity refers to the efficiency or ease
with which an asset or security can be converted in to ready cash without affecting its market
value; the risk arises when a company cannot buy or sell an investment in exchange for cash fast
enough to pay its debit, (Kenton, 2021). In such circumstance, banks will be exposed to liquidity
problem and may frustrate their costumers and may affect the financial sector as a whole. On the
other hand, when banks hold excess liquid asset which are non-earning assets such as cash and
non-interest bearing deposits, the bank‘s profitability will be affected.

Hence, every bank has to ensure that it operates to satisfy its profitability target and at the same
time to meet the financial demands of its customers by maintaining optimum level of liquidity.

2.2.2. Bank Liquidity Creation -Theory

According to Yeager et al, (1989) liquidity is a financial institution's ability to meet all financial
demands. The Basel Committee on Banking Supervision (BCBS) defines bank liquidity as the
bank's capability to fund increases in assets and satisfy obligations at short notice with little
acceptable losses. To compute bank liquidity, many empirical studies employ ratios calculated
from accounting data such as a ratio of liquid assets to total assets (Bunda, I &Desquilbet,,
2008). Nevertheless, using such liquidity ratios could be imprecise under certain circumstances
such as the Southeast Bank of Miami case. Despite having liquid assets to total assets above
30%, that bank went bankrupt due to its inability to repay some liabilities claimed on-demand
with its liquid assets (Distinguin et al., 2013).Drawing on the use of liquidity transformation to
measure liquidity creation, (Allen N. Berger and Christa H.S. Bouwman, 2007), develop a
comprehensive set of indicators. To construct their liquidity creation measures, they classify all
bank assets, liabilities, equity, and off-balance sheet activities as liquid, semiliquid, or illiquid.
After assigning weights to the activities classified earlier, they construct four liquidity creation
measures by combining the activities as classified and weighted previously in different ways.
The measures classify all activities other than loans by product category (i.e. ‗cat‘) and maturity

11
(i.e. ‗mat‘). To assess how much liquidity banks create on the balance sheet versus off the
balance sheet, they alternatively include off-balance-sheet activities (i.e. ‗fat‘) or exclude them
(i.e. ‗nonfat‘). The measures developed by (Berger, A, Bouwman,, 2009), have been the most
widely accepted and employed in bank liquidity research so far.

The researchers like (Hackethal, A., Rauch, C., Steffen, S., and Tyrell, M. , 2010), identified that
there is a strong and persistent positive influence of general economic strength with liquidity
creation; the stronger the economy, the larger is the amount of liquidity creation. Liquidity
creation strongly depends on the given interest rate environment; the larger the yield curve
spread and, consequently, the lower the ECB main refinancing rate, the higher the created
liquidity.

Liquidity creation (LC) is one of the most important roles that banks play in the economy. Bank
liquidity creation – which incorporates loans, deposits, off-balance sheet guarantees, derivatives,
and all other balance sheet and off-balance sheet financial activities – is theoretically linked to
the economy. Bank loans, particularly those to bank-dependent customers without capital market
opportunities, are often thought to be primary engines of economic growth (Barclay, M &
Smith,, 1995). These loans also play an important role in affecting output through the bank
lending channel of monetary policy (e.g., Bernanke and Blinder, 1998), particularly for small
banks that tend to cater to small, bank-dependent firms (Kashyap, AK, Rajan, RG and Stein, JK ,
2002). Transactions deposits, another key component of LC, provide liquidity and payments
services which are essential to a well-functioning economy (Kashyap, AK, Rajan, RG and Stein,
JK , 2002). Off-balance sheet guarantees like loan commitments and standby letters of credit
allow customers to expand their economic activities because they are able to plan their
investments and other expenditures knowing that the funds to finance these expenditures will be
forthcoming in the future when needed (e.g., Boot, Greenbaum, and Thakor 1993). Moreover,
these guarantees are often used as backups for other capital market financing, such as
commercial paper and municipal revenue bonds, and in this way assist the capital markets in
financing economic growth. Similarly, derivatives, the other main type of bank off-balance sheet
activity, aid real economic activity by allowing firms to hedge risks related to future changes in
interest rates, foreign exchange rates, and other market prices (e.g. Stulz, 2003). These
connections between the components of LC and real economic activity may be seen as part of the

12
more general literature on the effects of finance on the real economy (Barclay, M & Smith,,
1995). Despite the theoretical links between LC and the economy, the empirical literature until
now is missing any test of whether LC affects real economic output, measurement of how large
such an effect may be, and whether this effect is stronger than that of more traditional measures
of bank output, such as total assets.

2.2.3. Keynes Motives of Money Theory

The literature in economics and finance examines potential justifications for businesses holding
liquid assets.

Keynes, (1936) Distinguished three reasons why people like and want liquidity. The transaction
motive in this case is that businesses hold cash to meet their demands for cash inflows and
outflows. Cash is kept on hand to conduct transactions, and the need for liquidity serves this
purpose. The amount of income, the intervals between receiving it, and the ways in which it is
spent all have an impact on the need for cash. Holding cash for precautionary purposes acts as a
company's emergency fund. If anticipated cash inflows do not received as anticipated, cash on
hand could be utilized to pay short-term obligations for which it may have been benchmarked.
Holding cash for speculative purposes enables a company to seize unique chances that, if taken
advantage of immediately, will benefit the company.

2.2.4. Bank Liquidity Creation and Financial Fragility-Theory

According to the theory of financial intermediation, one significant function of banks in the
economy is to supply liquidity by funding long-term, illiquid assets with short-term, liquid
liabilities. Banks perform the role of liquidity providers by holding illiquid assets, providing cash
and demand deposits to the rest of the economy, and creating liquidity. In order to support the
existence of banks, (Diamond and Dybvig,, 1983), emphasize the "desire for liquidity" under the
uncertainty of economic agents. Banks exist because they offer better liquidity insurance than
financial markets. Banks, however, confront transformation risk and are vulnerable to the risk of
a run on deposits because they are liquidity insurers. In general, the risk for banks to incur losses
from selling illiquid assets to satisfy client liquidity requests increases with the amount of
liquidity created for the external public. Initially, a natural explanation for why deposit-taking
institutions exist was modeled, providing an explanation for the crucial function that banks play
in the economy by supplying liquidity. (Diamond and Dybvig,, 1983)

13
An analysis similar to this was done by (Kashyap, 2002), to support the need for banks to create
liquidity. They contend that since banks do deposit taking and lending under one roof, there must
be synergies between these two activities. By maintaining liquid assets as collateral against
withdrawals, deposits and loan commitments are secured in a way that creates synergy. These
liquid assets are seen by them as expensive overhead. The two distinct functions can share these
overheads, which is why there is synergy.

The relationship between a lack of liquidity and systemic financial crises is well examined by
(Diamond, DW., and Rajan, RG., 2005). It is suggested that the failure of one bank can reduce
the amount of liquidity that is available to the point where other banks may also be impacted. As
a result, there is a contagion effect. It is challenging to pinpoint the cause of a crisis, though,
because solvency and liquidity impacts interact. Liquidity risk typically results from banks'
essential role in converting short-term deposits into long-term loans at maturity.

2.3. Internal Factors Affecting Bank Liquidity

Theoretically factors affecting bank liquidity are mainly divided into two categories, this are
internal and external factors. The internal (bank-specific factors) are factors that are related to
internal efficiencies and managerial decisions. Such factors include determinants such as bank
non-performing loan, bank capital adequacy, bank size, asset management operational efficiency
and the like. The external or macro determinants are variables that are not related to bank
management but reflect the economic and legal environment that affects the operation and
liquidity positions of institutions. The macroeconomic factors that can affect bank liquidity
include factors such as GDP, FDI, NBE-bill purchase, interest rate and inflation rate are among
others (Syed Quaid Ali Shaha, Imran Khana et al. 2018).

2.3.1. Bank Size and Bank Liquidity

According to the ―too big to fail‖ argument, large banks would benefit from an implicit
guarantee, thus decrease their cost of funding and allows them to invest in riskier assets
(Iannotta, G, Nocera, G, and Sironi, A, 2007,). Therefore, ―too big to fail‖ status of large banks
could lead to moral hazard behavior and excessive risk exposure. If big banks are seeing
themselves as ―too big to fail‖, their motivation to hold liquid assets is limited. In case of a
liquidity shortage, they rely on a liquidity assistance of Lender of Last Resort. Thus, large banks
are likely to perform higher levels of liquidity creation that exposes them to losses associated

14
with having to sale illiquid assets to satisfy the liquidity demands of customers. Hence, there can
be positive relationship between bank size and illiquidity. However, since small banks are likely
to be focused on traditional intermediation activities and transformation activities (Rauch et al.
2008; Berger and Bouwman 2009) they do have small amount of liquidity. Hence, there can be
negative relationship between bank size and illiquidity.

2.3.2. Capital Adequacy and Bank Liquidity

The main reason banks hold capital is to absorb risk. This includes liquidity crisis risk, bank run
protection and various other risks, especially credit risk. The reason banks hold capital is
motivated by their role in risk transformation, but recent theory suggests that bank capital can
also influence a bank's ability to generate liquidity. Suggesting, these theories produce
conflicting predictions about the relationship between capital creation and liquidity creation.
Financial fragility replacement theory predicts that as capital increases, liquidity generation
decreases. (Diamond, DW and Rajan, RG , 2000,2001), focus on financial fragility. They model
themselves as relationship banks that raise money from investors to fund entrepreneurs.
Entrepreneurs can forego their efforts, thereby reducing the amount of bank loans they get. More
importantly, banks may be holding back, limiting their ability to raise funds. Deposit contracts
alleviate bank holdup problems, because if the bank threatens to withhold the deposit, the
depositor can run to the bank. Thus liquidity generation is maximized. Investors are unable to
rush to banks, limiting their willingness to fund and reducing liquidity formation. The higher a
bank's capital adequacy ratio, the less liquidity it creates.

Moreover, the negative impact of capital on liquidity generation proposed by (Diamond, DW and
Rajan, RG , 2000,2001), relies heavily on imperfect deposit insurance. With deposit insurance in
place, depositors have no incentive to stay with the bank, and deposit contracts do not alleviate
the bank's holdup problem. Moreover, (Gorton, G and Winton, 2000), show that high capital
ratios can reduce liquidity generation through another effect, transfer of deposits. They believe
that deposits are a more effective liquidity hedge for agents than investing in bank stocks. In fact,
deposits are fully or partially guaranteed and can be withdrawn at face value. Bank capital, by
contrast, is ineligible and has a stochastic value that depends on the health of the bank and the
liquidity of the stock market. As a result, higher capital ratios shift investors' fund from relatively

15
liquid deposit to relatively less liquid bank asset .Therefore, the higher the bank's capital
adequacy ratio, the lower the liquidity generation

2.3.3. Profitability and Bank Liquidity

The relationship between profitability and liquidity varies among different literatures. According
to Brock, P. and Suarez (2000), banks holding more liquid assets benefit from a superior
perception in funding markets, reducing their financing costs and increasing profitability. On the
other hand, Molyneux P. and Thornton J. (1992) and Goddard, Molyneux, and Wilson (2004)
argued that holding liquid assets imposes an opportunity cost on the bank and has an inverse
relationship with profitability. Further, Myers, S., and Rajan (2000) emphasized the adverse
effect of increased liquidity for financial institutions, stating that "although more liquid assets
increase the ability to raise cash on short notice, they also reduce management‘s ability to
commit credibly to an investment strategy that protects investors," which, finally, can result in a
reduction of the "firm‘s capacity to raise external finance" in some cases. Thus, this indicates a
negative relationship between bank profitability and liquidity. The trade-offs that generally exist
between return and liquidity risk are demonstrated by observing that a shift from short-term
securities to long-term securities or loans raises a bank's return but also increases its liquidity
risks. As a result of the two opposing views, the management of banks is faced with the dilemma
of liquidity and profitability.

2.3.4. Asset Management

Banks can mobilize assets in a number of ways. It can get the loan back soon or on short notice,
and it can sell stocks. Alternatively, banks can borrow money from a central bank and use
securities representing investments or loans as collateral. Banks are in no hurry to foreclose on
loans or sell marketable assets because it can interrupt sensitive debtor-creditor relationships,
weaken trust, and lead to bank crackdowns. Banks can therefore either hold some cash reserves
and other liquid assets or have access to lenders of last resort, such as central banks. In many
countries, commercial banks are temporarily required to maintain liquidity coverage ratios.
Among commercial bank assets, investments are less liquid than money market investments.
However, maintaining an appropriate maturity spread (combining long-term and short-term
investments) can ensure that some of the bank's investments can be repaid on a regular basis.
This creates a steady stream of liquidity and forms a secondary liquidity reserve. However, banks

16
are forced to "borrow short-term and lend long-term" due to the need to convert large portions of
their debt into cash on demand. Since most bank loans have a fixed maturity date, banks must
exchange notes that can be cashed at any time for notes that mature on a specified future date.
This exposes even the most solvent banks to liquidity risk—the risk of not having enough cash
(base money) to meet the demand for immediate payment. Banks manage this liquidity risk in
different ways. One approach, known as wealth management, focuses on adjusting a bank's asset
mix (loan, securities, and cash portfolios).

This approach leaves little control over a bank's debt and overall size. Both of these depend on
the number of customers who deposit their savings with the bank. In general, bankers construct a
portfolio of assets that can generate the maximum interest income while keeping the risk within
acceptable limits. Also, banks must keep aside enough cash reserves to cover routine needs, such
as the requirement for reserves to fulfill minimum statutory standards, while focusing the
remainder of their resources mostly on short-term commercial loans. Due to the abundance of
short-term loans among a bank's assets, some bank loans are perpetually due, allowing a bank to
satisfy unusual cash withdrawals or settlement obligations by forgoing the renewal or
replacement of some maturing loans. (https://www.britannica.com/topic/bank/Asset-)

2.3.5. Operational Efficiency

In a business context, operational efficiency is a measure of resource allocation and can be

defined as the ratio of the output obtained from the business to the input into business operations.
Improving operational efficiency improves the ratio of output to input. Inputs are typically
money (cost), people (measured as headcount or full-time equivalents), or time or effort. Outputs
are typically money (revenue, margin, and cash), new customers, customer loyalty, market
differentiation, production, innovation, quality, speed and agility, complexity, or opportunity. It‘s
common to use the terms "operational efficiency," "efficiency," and "productivity"
interchangeably. "An Introduction to Efficiency and Productivity Analysis" explains how
efficiency and (total factor) productivity differ from one another. [1] To further muddy the term,
operational excellence—which is about continual improvement and goes beyond efficiency—is
sometimes used to refer to operational efficiency. Operational efficiency and operating
excellence are occasionally used interchangeably. According to (Eissa A. Al-Homaidi, 2019)
operation efficiency has a direct impact on the liquidity of commercial banks. Commercial

17
banks' liquidity level would improve if they employed their resources wisely and managed their
plans correctly.

2.3.6. Deposit Growth and Bank Liquidity

Mussa (2015) found an insignificant effect of deposits on bank liquidity. Bonner and Zymek
(2013) and Kashyap (2002) argued that as demand deposits increase, liquidity asset holdings also
increase. Alger and Alger (1999) provided empirical insights into liquid assets held by Mexican
banks. This study summarized 10 predictions based on various theories and applied panel data
estimates from January 1997 to March 1999. They assumed that at a given level of deposits, if
there is more risk for borrowers, as in the case of an economic recession, liquid assets should
also be increased by banks. (Pilbeam, 2005) studied emerging economies for the period of 1994
to 2004 and found that as the deposit rate increases, bank liquidity decreases. Wubayehu (2017)
revealed that the level of deposit had a statistically significant and negative relationship with
banks‘ liquidity.

2.4. Macroeconomic Factors Affecting Liquidity

2.4.1. Gross Domestic Products (GDP)
Gross Domestic Product (GDP) measures the national income and output of a given country's
economy. Gross Domestic Product (GDP) is the total expenditure on all final goods and services
produced within a country within a specified period of time (www.investopdia.com). It is a
gauge of a nation's economic activity level. It is an index of national health. It is also employed
as a business cycle indicator. According to the theory of bank liquidity and financial fragility,
strong GDP growth indicates a rise in business activity, which has a negative impact on bank
liquidity because banks increase lending, and vice versa. As a result, GDP and liquidity are
negatively interrelated. Sheefeni and Nyambe (2016) found that GDP growth had a negative
impact on liquidity in the long run. On the other hand, a study conducted by Vodová (2013) on
the Visegrad countries found a positive relationship between liquidity and GDP growth. She
argued that companies need time to accumulate profits and savings before reducing their share of
external funding. This will improve bank liquidity. A study by Bunda, I., and Desquilbet, J.
(2008) also found a positive relationship between liquidity and GDP.

18
 2.4.2. Reserve Requirement
A bank operating in Ethiopia shall maintain in its reserve account stated under article 2.1(a) of
this directive, on average in every calendar month, 7% of all birr and foreign currency deposit
liabilities held in the form of demand/current deposit, saving deposit, and time deposit, NBE
Directive No.SBB/84/2022. In our case, these costs will be calculated as the proportion of
required reserves put in the national bank to total assets. A Positive correlation with the
dependent variable is expected because a higher level of reserves (remunerated by lower interest
rates) will affect the bank's behavior in setting higher loan rates to compensate for the missing
profit from investing these funds.
Few studies have observed the influence of funding costs and funding sources on bank liquidity
(Bunda, I., &Desquilbet, 2008). Alger & Alger, (1999) And Munteanu (2012) further explained
that if refinancing costs increased, banks tended to invest more in liquid assets. This means that
if liability costs increase, banks, instead of relying on the interbank market, tend to rely more on
liquid assets that act as a source of liquidity.

2.4.3. NBE-bills Purchase and Bank Liquidity: The National Bank of Ethiopia‘s NBE- bills is
long-term obligations with a maturity of five years and an interest rate of three percent annually
(NBE directive number MFA/NBEBILLS/001/2011). Since 2011, commercial banks in Ethiopia,
excluding the Commercial Bank of Ethiopia (CBE), have been required to purchase NBE bills,
which account for 27% of new loan disbursements. In line with this directive, NBE issued an
additional requirement that commercial banks maintain a portfolio of short-term loans with a
composition of not less than 40%. This NBE bill has a maturity period of five years. The study
by Beléte, (2015) examined the NBE-Bill purchase as having a primarily serious adverse impact
on banks liquidity as it boldly changed liquid assets to illiquid long-term investments. In addition
to this, Wubayehu, (2017) and Rahel, (2019) found that the NBE-bill purchase had a strongly
significant, even at a significant level of 1%, negative impact on bank liquidity.

19
 2.5. Empirical Review
In this section the researcher reviews other country and Ethiopia studies that have been
previously done by various researchers and are related or are relevant to the research study.

2.5.1. Empirical Review of International Studies

Eissa A. Al‐Homaidi, Mosab I. Tabash, Najib H. Farhan & Faozi A. Almaqtari, (2019)
examined the determinants of liquidity (LQD) of listed commercial banks in India. The study
applied both GMM and pooled fixed and random effects models to a panel of 37 commercial
banks listed on India's Bombay Stock Exchange (BSE) for the period 2008-2017. LQD of banks
was used as the dependent variable acting on both bank-specific and macroeconomic
determinants. The findings showed that among the bank-specific factors, bank size, capital
adequacy ratio, deposits ratio, operational efficiency ratio, and return on assets ratio are found to
have a significant positive impact on LQD, while assets quality ratio, assets management ratio,
return on equity ratio, and net interest margin ratio are found to have a significant negative
impact on LQD. When we come to macroeconomic issues, interest rate and exchange rate are
proven to significantly affect LQD. To achieve a smooth LQD of commercial banks in India, the
Reserve Bank of India (RBI) should provide benchmarks for the above-mentioned ratios. The
study made the suggestion that bankers should take into account asset quality in a manner that
enhances banks' efficiency.

Using data spanning the years 2001 to 2010, Vodová, (2013) sought to determine the factors that
influence commercial banks' liquidity in Hungary. According to the panel data regression
analysis results, bank liquidity has a positive link with bank capital adequacy, loan interest rates,
and profitability while having a negative correlation with bank size, interest margin, monetary
policy interest rate, and interbank interest rates. Uncertainty exists in the relationship between
the GDP growth rate and bank liquidity. According to empirical research (Valla, N, Saes-
Escorbiac, B &Tiesset, , 2006), (Bunda, I &Desquilbet, J, 2008); (Lucchetta, 2007); (Fie05),
there are numerous macroeconomic and bank-specific factors that affect the liquidity of
commercial banks around the world (Hackethal, A., Rauch, C., Steffen, S., and Tyrell, M. ,
2010). (Valla, N, Saes-Escorbiac, B &Tiesset, , 2006), examine both bank-specific and
macroeconomic determinants of English banks and discovered that the likelihood of receiving

20
support from the lender of last resort, interest margin, and bank profitability, size of the bank,
GDP growth, and short term interest rate affect the liquidity ratio as a measure of liquidity.

In a study by Bunda, I &Desquilbet, J, (2008) they looked at the factors that influence the
liquidity risk of banks in emerging markets using panel data regression analysis. They discovered
that the liquidity ratio, which serves as a measure of a bank's liquidity, is thought to depend on
the actions of the individual banks, the macroeconomic and market environment in which those
banks operate, and the regime of exchange rates that encourages risk-taking among banks with
high liquidity. The liquidity ratio is influenced by factors such as bank size, the occurrence of a
financial crisis, and the lending interest rate as a gauge of lending profitability. The realization of
a financial crisis, which could be brought on by inadequate bank liquidity and is anticipated to
have a negative impact on banks' liquidity; total assets as a measure of the size of the bank; the
lending interest rate as a measure of lending profitability; and the presence of prudential
regulation., which refers to the requirement that banks have adequate liquidity, the share of
public spending on GDP as a measure of the supply of relatively liquid assets, the rate of
inflation, which increases the vulnerability of banks to the nominal values of loans made to
customers, and the exchange rate regime, where banks were more liquid in countries with
extreme regimes (the independently floating exchange rate regime and hard pegs) than in those
with intermediate regimes are expected to have positive impact on banks liquidity.
Additionally, Hackethal,et al (2010) examined how the financial crisis affected the liquidity of
commercial banks in countries throughout Latin America and the Caribbean and proposed that
liquidity is negatively impacted by customer cash requirements, as measured by changes in the
cash-to-deposit ratio and money market interest rate, and is positively impacted by the current
macroeconomic situation, when a cyclical downturn should reduce banks' anticipated money
demand from transactions and hence cause liquidity to decline. The findings of this study
suggested that monetary policy interest rate, where tightening monetary policy reduces bank
liquidity, level of unemployment, which is related to loan demand, size of the bank as measured
by the total number of bank customers, and bank profitability all have a significant negative
impact on the liquidity ratio. In contrast, savings quota and level of liquidity are found to have a
positive and significant impact on the liquidity position of the bank under consideration.

21
The liquidity created by the German state savings bank and its determinants was analyzed by
Rauch, C, et,al (2008). This study had two purposes. First, an attempt was made to measure the
liquidity generated by all 457 German state savings banks in the period 1997-2006. In a second
step, the impact of monetary policy on banks' liquidity generation was analyzed. In this
study, the researcher measures the created liquidity according to the calculation method of
(Berger,A and Bouwman,, 2007), and (Deep, A and Schaefer, G, 2004). This study created a
dynamic panel regression model to evaluate the influence of monetary policy. The following
variables can affect bank liquidity, according to this study: Monetary policy interest rates, where
tightening monetary policy is anticipated to reduce bank liquidity, unemployment rates, which
are associated with loan demand and have a negative impact on liquidity, savings rates, liquidity
levels from prior periods, size of the bank as indicated by the sum of all customers, and bank
profitability are anticipated to have a negative impact on bank liquidity. The researcher used
bank balance sheet data as well as general macroeconomic data to conduct the tests of measuring
liquidity and analyze relevant factors on bank liquidity. The control variable for the overall
macroeconomic influence demonstrates that the production of bank liquidity and the general
health of the economy are positively correlated. More liquidity is created as the economy gets
healthier. Also, it was discovered that banks with greater interest-to-provision-income ratios
generate more liquidity. Other bank-related factors, such as size or performance, did not have a
statistically significant impact on the banks' ability to provide liquidity.

2.5.2. Related Ethiopian Empirical Studies on Liquidity

Rahel (2019) investigates the macroeconomic, industry-specific, and bank-specific variables
influencing the liquidity of Ethiopian commercial banks. The information spanned the years
2000 to 2017 GC for the sample of six private commercial banks that were chosen. This study
used an explanatory design and a quantitative research methodology. Purposive sampling was
used to gather secondary data from the six private commercial banks that were chosen. The
study's conclusions indicate that the following factors have a negative and statistically significant
impact on liquidity: Bank size, Capital adequacy ratio, Reserve requirement, Interest rate spread,
Loan growth, and NBE bill purchase. On the other hand, positive and statistically significant
effects on liquidity are caused by increases in deposits, profitability, non-performing loans,
foreign exchange rate fluctuation, and inflation. The study advises banks to think about both
internal and external elements in order to increase operational effectiveness and maximize their

22
liquidity position rather than only internal policy. On the other hand, the NBE, who makes
policy, must take into account the state of the economy and support a climate that would foster
the growth of the financial sector.
Tseganesh (2012) studied Determinants of Banks Liquidity and their Impact on Financial
Performance: Empirical study on Commercial Banks in Ethiopia aimed to identify Determinants
of Banks Liquidity in Ethiopia and then to see the Impact of Banks Liquidity up on Financial
Performance through the Significant Variables Explaining Liquidity. Using balanced fixed effect
panel regression, eight sampled commercial banks in Ethiopia's data from 2000–2011 were
examined for eight factors that affected banks' liquidity.
According to the findings of panel data regression analysis, the liquidity of banks was positively
and statistically significantly impacted by capital adequacy, bank size, the percentage of non-
performing loans in the total volume of loans, interest rate margin, inflation rate, and short term
interest rates. Loan growth and the real GDP growth rate had no statistically significant effect on
bank liquidity. Capital sufficiency and bank size were among the statistically significant factors
affecting banks' liquidity; in contrast, non-performing loans and short-term interest rates had a
negative impact on financial performance. The impact of interest rate margin and inflation on
financial performance was negative but statistically negligible. Consequently, there was a non-
linear/positive and negative effect of bank liquidity on financial performance

Wassihun (2020) Research conducted by Wassihun Tamene Commercial banks are mostly
concerned with creating liquidity since they mobilize deposits and lend money, which directly
affects their liquidity. So, the focus of this study is on the factors that affect Ethiopian
commercial banks' liquidity. For the sample of seven commercial banks that were chosen, the
data covered the years 2000 to 2018 G.C. for the sample of seven commercial banks that were
chosen. This research was conducted using a quantitative technique and an explanatory research
design. Purposive sampling was used to gather secondary data from the chosen seven
commercial banks, and the Ministry of Finance and Economic Development (MOFED) provided
macroeconomic data. The study's findings indicate that factors such as bank size, inflation, non-
performing loan GDP, and loan growth have a negative and statistically significant impact on
liquidity. Liquidity is positively and statistically significantly impacted by asset quality and
interest rate spread. According to the study, strengthening the focus and reengineering of the
banks as well as the important internal drivers could improve the liquidity position of Ethiopia's
23
commercial banks. When establishing strategies to strengthen their liquidity positions, Ethiopian
banks must take into account both their internal environments and the macroeconomic
environment in addition to internal structures and rules. On the other hand, the NBE, who makes
policy, must take into account the state of the economy and support a climate that would foster
the growth of the financial sector.

Nigist (2015) conducted a study titled "Determinants of Banks Liquidity: Empirical Data on
Ethiopian Commercial Banks" with the purpose of determining the factors that affect the
liquidity of commercial banks in Ethiopia. The researcher Used secondary data from ten
commercial banks in Ethiopia that were randomly selected and collected from 2007 to 2013. By
using the balanced panel fixed effect regression model, both bank internal and external factors
were examined.
The study's findings revealed that while bank size has a positive and statistically significant
impact on liquidity, capital adequacy, profitability, and real GDP growth rate have negative and
statistically significant effects on the liquidity of Ethiopian commercial banks. Nonperforming
loans, loan growth, inflation, and interest rate margin, on the other hand, were shown to be
statistically insignificant or to have no effect at all on the liquidity of Ethiopian commercial
banks throughout the test period.

2.6. Conclusion and Knowledge Gap

In line with the theoretical and empirical research above, liquidity is important for all businesses,
especially in the bank industry. Its function is to create liquidity on both the asset and liability
side of the balance sheet. Almost every financial transaction or obligation affects bank liquidity.
Effective liquidity risk management helps ensure a bank's ability to meet its cash flow
obligations. Cash flow obligations are uncertain because they are affected by external events and
actions of other parties.
As it was discussed in the literature review part, liquidity of banks can be affected by bank
specific and macroeconomic factors. It was also discussed that some factors which have
significant impact on liquidity of banks in one country may not have the same impact on another
country. Thus it is important to identify the factors that influence liquidity of selected Ethiopian
commercial banks.

24
In addition, as we have seen from the empirical studies all the researchers were focused on bank
specific and macro-economic factors of liquidity. Even the researcher‘s focuses on bank specific
/industry factors as well as macroeconomic factors, like the impact of Banks asset Management
Bank service Quality and Operation Efficiency are not considered. But the factors that are
mentioned have direct influence on bank‘s liquidity position.

2.7. Conceptual Framework

The conceptual frame work which describes the relationship between bank liquidity with bank-
specific and macroeconomic determinants based on the theoretical and empirical perspectives
was formulated as follows.

Factors affecting Bank Liquidity (LIQ)

Internal Factors/ Bank-specific External Factors/

factors Macroeconomic factors

 Bank size
 GDP
 Capital adequacy
 Required Reserve
 profitability
 NBE-bill purchase.
 Assets management
 Operation efficiency
 Deposit growth

Figure1.Relationship between liquidity and its determinants (own drafting)

25
 CHAPTER THREE

RESEARCH METHODOLOGY AND DESIGN

3.1. Introduction
Research Method: The purpose of this chapter is to go over the approaches used throughout the
study to achieve the study's objectives. The exact procedures or methods used to find, select,
process, and analyze information about a topic are known as research methodology. It is a
means of outlining a researcher's intended method of investigation. Explanatory study
methodology was used in a quantitative research strategy to investigate the cause and effect
relationships between variables. Data for this study comprises only secondary data, audited
financial statements particularly balance sheet and income statement or profit and loss statement,
obtained from each selected commercial banks. The purpose of this chapter is to present the
research approach, variables and hypotheses, and to briefly indicate what type of data used, from
where data is collected, and how relevant data is collected and analyzed to achieve the study
objectives.

3.2. Research Design

An overall strategy for how we will respond the research questions is referred to as the research
design. Research design, as stated in Creswell, (2009) is a strategy for carrying out research. A
research design is a method for employing empirical data to address your research problem. Making
judgments regarding your general study objectives and approach, the type of research design you'll
employ, your sample techniques or selection criteria, your methodology, the steps you'll take to
gather data, and your data analysis techniques are all part of creating a research design. Written by
(Shona, 2021), the researcher analyzes and critically evaluates the data and information using the
facts and knowledge already at hand. Research can be categorized as descriptive, explanatory, or
exploratory depending on the particular goal that it attempts to meet. In order to describe and
explain what is, descriptive research focuses on people, groups, institutions, procedures, and
materials. Descriptive research also compares, contrasts, categorizes, analyzes, and interprets the
objects and events that make up the diverse disciplines of study. It aims to describe the situation

26
as it is right now. Explanatory research, on the other hand, aims to establish the cause and effect link
between variables.

Exploratory research focuses on gathering background knowledge and aids in the better
understanding and clarification of a topic. It is less formal and perhaps completely unstructured and
is usually based on secondary data and concentrates on the development of new ideas. Since the
goal of this study is to determine the cause and effect relationship between variables, explanatory
research was performed.

3.3. Research Approach

There are three distinctive kinds of research methodologies: quantitative, qualitative and mixed
methods, (cresswell, 2014), As he says, a quantitative approach interprets analysis of an idea by
formulating specific hypotheses and using data collection to either confirm or disprove the
hypotheses. Statistical techniques and assumption testing are used to examine the data from
measuring attitudes, whereas the qualitative method focuses on determining the relevance of a
particular phenomenon from the participants' point of view and tracking it through time. A mixed
method approach necessitates research and data collecting from both quantitative and qualitative
approaches, which may involve logical and theoretical basis. The data collection is collected by
observing participants' behavior while they are participating in activities (cresswell, 2014).
In line to this, the researcher thought the quantitative research approach was appropriate. This is
due to the fact that the quantitative approach is an investigation that is based on the assumption
that characteristics of the social environment create an objective reality that is largely consistent
across time and location (Gall, 1996) , As they continued, the general methodology is to describe
and explain this real-life feature by collecting numerical data on the observable behavior of the
sample and subjecting this data to statistical analysis, which is required for this study. In
addition, quantitative studies test theories a priori from existing knowledge by developing
hypothetical relationships and proposed outcomes. And to get to that point, this research
approach must use a review of the existing literature to deductively develop the theories and
hypotheses to be tested, transforming the research problem into specific variables. (Yesegat,
2009).According to Yesigat's additional observations, quantitative research methodologies test
the theoretically established link between variables using sample data with the aim of statistically
generalizing for the population under study and Due to the quantitative character of the data

27
employed in this study and the researcher‘s desire using secondary data, a quantitative research
approach was adopted.

3.4. Population and Sampling Frame

The population of the study includes all commercial banks that are operating in Ethiopia.
According to NBE report, a meeting held with CEOs of the bank on August 08, 2022 the
number of banks has reached a total of 30, which is around 29 commercial banks in Ethiopia
since excluding development bank of Ethiopia. The target population (sample frame) of this
study was ten selected Ethiopian commercial banks that are operating in Ethiopia. namely ,
Awash Bank S.C (AB), Dashen Bank S.C (DB), Bank of Abyssinia S.C (BOA),Wegagen Bank
S.C(WB),Nib international bank(NIB),Oromia international bank S.C(OIB), Hibert Bank S.C
(HB), Cooperative Bank of Oromia (CBO), Lion International Bank S.C (LIB) Zemen Bank
S.C(ZB).Therefore, the matrix for the frame is 10*5 that includes 50 observations.

Table 1 Sample Banks

Name of sampled banks Year start to operation

Awash bank 1994

Dashen bank 1995

Bank of Abyssinia 1996

Wegagen bank 1997

Hibert bank 1998

Nib international bank 1999

Cooperative bank of oromia 2005

Lion international bank 2006

Zemen bank 2008

Oromia international bank 2008

Source: Own drafting

28
3.5. Sampling Technique
To conduct this study the researcher used Purposive /judgmental sampling. This technique is one
of the non-probabilistic sampling techniques used a non-probabilistic sampling approach.
According to Saunders, M.et al ,( 2012), Purposive/judgmental sampling, is a non-probability
sampling technique, used when elements selected for the sample are chosen by the researcher's
judgment. Purposive sampling is used when there is large population size, to select a member of
a difficult to reach specialized population and to identify particular types of respondents for in
depth investigation. By considering the access of full data for the selected time period, due to
large population size and time resource constraints the researcher used purposive sampling
technique.

3.6. Sample Size

For the purpose of this study ten commercial banks were selected. The selection criteria set by
the researcher was first, the required banks are only Commercial banks operating in Ethiopia.
Second, those commercial banks should have started operation before 2009 so that they can have
financial statements for required years, third those commercial banks compulsory to purchase
NBE-bills and forth commercial banks having at least fifteen years operating in Ethiopia. On
the base of the aforementioned criteria ten commercial banks for five year data ware taken for
this study. As a result, a sample of 50 observations has been used because it is viable in line
with time and funds available for this study.

3.7. Data Source and Collection Instrument

To achieve the purpose of the study, the researcher depends solely on secondary data taken from
audited financial statement, NBE and from World Bank Collected through structured document
review. The data characterized as panel data, which capture both the cross section and time series
dimensions. (Baltagi, 2005), cited in (Chen, 2022), described the advantages of panel data as a
way to increase number of data points , degree of freedom, and to reduce co-linearity among
explanatory variables that lead to improve the efficiency of econometric estimates. They noted
additionally, it can also control for individual heterogeneity due to hidden factors that if
neglected in time series or cross sectional estimation which leads to biased result. (Eric, 2019),
Panel data, sometimes referred to as longitudinal data, is data that contains observations about

29
different cross sections across time; minimize estimation biases that may arise from aggregating
groups into a single time series, by this rational the researcher chooses to use panel data type.

3.8. Study Variables Description

3.8.1. Dependent Variable

Bank Liquidity: Fool, (2016), liquidity, or the amount of cash or cash like assets on the
balance sheet, is critical for any banks. Bank must meet funding needs for their operations, they
must be able to repay their own debts, and they must have enough cash on hand to meet
withdrawal requests, and fund new loans for customers.
Investors should usually pay very close attention to bank liquidity positions because it is the
fastest way for a bank to fail. The most widely used measurement for bank liquidity is the ratio
of total liquid assets to total assets (Vodova, 2012), which describes liquidity as "the ability of
bank to fund increase in assets and satisfy obligations as they come due, without incurring
unacceptable losses."
The relative amount of an asset that is in cash or that can be swiftly changed into cash without
suffering a loss in value is referred to as liquidity and it is used to meet short-term liabilities.
Liquidity ratios (stock approach) and liquidity gaps (flow approach) are the two ways that banks'
liquidity can be measured, as was previously described in the literature. The liquidity gap is the
difference between assets and liabilities; in contrast, liquidity ratios are several balance sheet
items ratios that show trends in liquidity. The liquidity metric offers suggestions regarding the
level of liquidity on which the commercial banks are working. The first approach liquidity ratio
uses various balance sheet items and is simple to calculate, whereas funding gap, the second
approach, is the difference between inflows and outflows, which is hard to measure because it
requires more data and there is no Standard method to forecast inflows and outflows. Due to the
availability of data, this study will employ liquidity ratios to estimate the liquidity of commercial
banks and liquidity ratio is the preferred method in the majority of academic literature due to a
more standardized method. Various authors (Aspachs et. al., 2005), (Praet, P and Herzberg,,
2008), provide various measurements of liquidity ratios. Such as, total liquid asset to total asset,
total liquid asset to total deposit, loans to total asset, and loans to total deposit.For the purpose of
evaluation of the liquidity positions of Ethiopian commercial banks (Wubayehu, 2017), NBE
Directive No. SBB/57/2014 requires banks to compute its liquidity ratio by dividing liquid assets to

30
total deposits. Therefore, the ratio of liquid assets to total deposits had been used to calculate
liquidity (dependent variable).

Liquidity (LIQ) = Total Liquid asset

Total deposit

According to NBE establishment proclamation (No. 591) liquid asset of banks includes cash on
hand, deposit in other bank, and short term government securities that are acceptable by NBE as
collateral (for instance Treasury bill).

3.9. Independent Variables

Bank Size (BS): bank size is measured by Natural log of total assets of private commercial
banks. (Bonner and Zymek, 2013), and (Delechat .C, Henao.C, Mathoora .P and Vtyurina .S.,
2012), stated that bank size negatively affects liquidity, yet its impact is significant. In contrast to
small banks, which must maintain adequate liquidity, large banks can arrange for fund from
external sources. It means that with an increase in bank size, liquid buffer of banks decreases.
Large banks may exploit economies of scale and this enables them acquire more client and
undertaking in more transactions which translate to more returns which leads more liquid.

Bank Size (BS) = Natural logarithms of total asset

Capital Adequacy of Banks (CAD): The term "capital" refers to the financial resources
that companies might employ to finance their activities, such as cash, equipment, machinery, and
other resources. These are the resources that enable the company to create a good or service to
provide to clients. Capital is the amount of own money that a bank has on hand to support its
operations and serve as a safety net in case of adversity (Athanasoglou, 2005). A bank's capital
consists of its paid-in capital, undistributed profit (retained earnings), legal reserve or other
reserves, and excess fund set aside for unforeseen circumstances. Deposits are the most fragile
and susceptible to bank runs, therefore banks' capital helps them maintain liquidity. Financial
distress is less likely with increased bank capital. The capital adequacy ratio (CAR) is used to
assess the capital adequacy of a company. Capital adequacy ratio shows the internal strength of
the bank to withstand losses during crisis as sited by (Dang, 2011), The proxy for capital
adequacy is the ratio of total capital and reserve of the bank to total asset of the bank. This study

31
considered there is a positive relationship between capital adequacy & liquidity as in the above
hypothesis.

Capital Adequacy Ratio (CAD) = Total Capital of the bank +Reserve in other bank

Total asset of the Bank

Profitability of the Bank (ROA): Liquidity needs constrain a bank from investing its entire
available fund. Banks need to be both profitable and liquid which are inherently conflicts between
the two and the need to balance them. As more liquid asset is investing on earning assets such as
loans and advances, profitability will increase by the expense of liquidity. As a result, banks should
always strike a balance between liquidity and profitability to satisfy shareholders‟ wealth aspirations
as well as liquidity requirements. For the purpose of this study, the proxy of profitability is return on
asset that measures the overall financial performance of banks and the return on asset (ROA) is
measured by the ratio of net profit after tax to Average total asset.

Profitability (ROA) = Net income after tax

Average total asset
Assets Management (AM): Wealth management and asset management are used
interchangeably. An asset manager oversees his or her clients' assets as a provider of financial
services. In addition to giving clients expert advice the work also entails selecting investment
choices depending on each client's investment strategy, risk tolerance, and financial position.
Asset management is aimed for wealthy individual and institutional investors who place their
money in liquid asset classes (equities) and other liquid and illiquid asset types (funds). This
study considered there is a positive relationship between asset management & liquidity as in the
above hypothesis. It can be measured as the ratio of operating income divided by total asset of
the bank.

Asset management (AM) = Operating income

Total Asset of the Bank
Operational Efficiency: Operational efficiency refers to an organization's or bank's capacity
to minimize waste in terms of time, effort, and materials while still delivering high-quality
services or goods. Operational efficiency is measured in terms of the ratio between the input
needed to maintain an organization's operations and the output it produces. A business's inputs
include things like costs, labor costs, and time, while its outputs include things like rapid

32
development times, high quality, revenue, and customer acquisition and retention. It is the ratio
of total operating expenses to total assets. This study considered there is a positive relationship
between Operation efficiency & liquidity as in the above hypothesis

Operation Efficiency (OPEF) =Total Operational Expense

Total Asset
Deposit Growth (DG): Deposits are the major source of funds for banks. However, banks are
required to maintain adequate liquidity to meet customer demand (Bonner and Zymek, 2013) And
(Kashyap, 2002), stated that as demand deposits increase, liquidity asset holdings also increase.

Deposit Growth (DG) =Customer deposit

Total asset

Gross Domestic Product (GDP): It measures the monetary value of the final goods and
services those purchased by the consumer produced in a nation over a specified time period (say a quarter
or a year). GDP totals all the output produced inside a nation's boundaries. According to research
(Painceira, 2010) on banks' liquidity preferences during various business cycles, their desire for
liquidity is low at the time of economic booms. Where, banks confidently expect to profit by expanding
loan able funds to sustain economic boom, whereas during economic downturn limit loanable funds in
order to prioritize liquidity. To sum up, banks prefer high liquidity due to lower confidence in reaping
profits during economic downturn. There is high demand for bank loan at the conditions of economic
boom than that of recession time (Gabriell, 2009) and (Andireas, 2009). As they proved in their studies,
there is positive relationship between banks financial performance and real GDP. As GDP of the countries
increase the demand of lending from bank is also increase.

Aspachs et. al., (2005), has also inferred that banks prioritize liquidity when the economy falls, during
risk lending opportunities, while neglecting liquidity during economic boom when lending opportunities
may be favorable. As a result, to the best of our knowledge, banks avoid lending during economic
expansion. Even (Valla, N, Saes-Escorbiac, B &Tiesset, , 2006), found a link between liquidity and
declining real GDP growth. Therefore, the study expected negative relationship between banks liquidity
and economic cycle.it measure the annual gross rate of Gross domestic product. For the purpose of this
study, GDP is measured by the annual real growth rate of gross domestic product and it is hypothesized to
affect banking liquidity positively.

33
Reserve Requirement: These costs in this case will be calculated as the proportion of
required reserves put in the national bank to total assets. A negative correlation with the
dependent variable is expected, because a higher level of reserves will affect a decrease in banks
liquidity.

Reserve Requirement (RR) = Total RR at NBE

Total Asset
NBE Treasury Bill Purchase (NBE-Bill): Evidently, the liquidity of a bank can be
significantly impacted by national bank bills. Government regulation which forced private banks
exclusively to make investment on bonds that amounts 27 percent of the total loans provided by
the banks to customers is currently affecting the Ethiopian private banks liquidity since huge
amount of loan able funds tied up in this bond (NBE Bills). A study shows that the national bank
bill has a negative influence on bank liquidity. Research in other country by (Berger A and
Bouwman, 2010), found that the monetary policy effects on-balance sheet liquidity creation. Thus,
NBE-bills purchase to total assets ratio was used as a proxy for measurement of NBE-bill purchase
and this study considered there is a Negative relationship between NBE Treasury bill purchases
with Bank liquidity.

34
Table 2 summary of explanatory variables and their anticipated effects

Variables Symbol Formulas Expected sign

Dependent variable
LIQ LIQ=total liquid asset
Bank liquidity Total deposit NA

Independent variables
BS Natural logarithm of total asset
Bank size Negative
CAD CAD= Equity
Capital adequacy Total asset Positive
ROA ROA= Net income after tax
Profitability of the Bank Average total asset Positive
AM
Asset Management AM=Operating expense Positive
total asset
OPEF
Operation Efficiency OPEF=total operating expense Positive
Total asset

Deposit growth DG Customer deposit Positive

Total asset
GDP
Gross Domestic Product Annual real GDP growth rate Negative
RR
Reserve Requirement RR= Total RR at NBE Positive
Total Asset

NBE Treasury bill purchase NBE-Bill The ratio of NBE-bill to total assets Negative

3.10. Ethical Consideration

Initially the researcher has considered ethical issues that was anticipated and described in this
thesis and related to all the phases of the study. Mainly the research outcome helps the banks
under the study and it were sources of information for others. Moreover, the researcher tries not
falsifying or distorts data or the methods of data collection or plagiarizes the work of other.
Finally, followed the best preparation for ethical behaviors like internalize sensitivity to ethical
concerns and adopt a serious professional role.

35
 3.11. Model Specification
General multivariate regression model applied to investigate the relationship that exists between
Liquidity of commercial banks in Ethiopia and each of explanatory variables that includes Bank
size, capital adequacy, Profitability, Asset management, operation efficiency, gross domestic
product, Reserve requirement and NBE-bill purchase, another factors that are not included in the
model expressed by error term in the model.

The study adopted the following general multivariate regression model, which is used to
examine the internal and external factors affecting banks liquidity, (Gujarat, 2004), (Vodová,
2013) and (Raeisi, 2014)

Yit = α + β.xit + uit

Where:
Yit represents dependent variables; subscript i denote the cross-section and t representing the
time-series dimension; xit is a vector of explanatory variables for bank i in time t; α is constant;
β are coefficient which represents the slope of the explanatory variables and uit is the error
term.
From the above general multivariate regression model, the following specific model (Cucinelli,
2013), was developed to test whether the commercial banks‟ liquidity was affected by the
selected variables involved in the study.

LIQ=βo+β1(BSit)+β2(CADit)+β3(ROAit)+β4(AMit)+β5(OPREFt)+β6(DGit)+β7(GDPit)
β8(RR t)+ β9(NBE-bill it)++U it
Where,

LIQ it = is liquidity ratio measured by L1 for ith bank on

year t.

BS it=is Bank size for bank i at time t.

CAD it =capital adequacy of bank i at time t

ROA it=profitability of bank I at time t

AM it=asset management for bank i at time t.

36
 OPEF it=operation efficiency for bank i at time t.

DG it=deposit growth rate of bank i at time t

GDP t=real gross domestic product/GDP growth of

Ethiopia the year t.

RR it=Reserve requirement of bank i at time t

NBE-bill it = is national bank bill purchase for bank i at

time t.

U it = is a random error term

3.12. Data Analysis Methods

The study was primarily based on panel data that were collected through structured document
review. The data entered into the Stata software used in this study was, analyzed by
descriptive statistics and regression analysis to achieve the objective of the study. Descriptive
analysis deal with variable descriptions whereas regression analysis is the most important part
of the analysis helps to identifying and determining variables effect and draw relationship
between dependent and independent variables. Pearson‘s correlation matrix test is used to
identify the relationship of each variable among them and with dependent variables, and various
specification tests has been done to check for assumptions of classical linear regression model:
Heteroskedasticity, Autocorrelation, Multicolinearity, and normality test are held along with a
test for either a fixed effect or random effect model is appropriate for the study (Malhotra, 2007).
Finally, the study applied the Ordinary Least Square (OLS) regression method to test the
influence of variables that influence the liquidity of selected commercial banks in Ethiopia. This
method was chosen because it can minimize the error between the estimated point on the line and
the actual observed points of the estimated regression line, providing the best fit. The effect of
each explanatory variable on liquidity was assessed using the statistical significance of the 'βs'
coefficient. Estimated coefficients were considered statistically significant using 1%, 5%, and
10% significance levels, a calculated coefficient was considered statistically significant if the p-
value was less than 0.01, less than 0.05, or less than 0.1 at 1%, 5%, and 10%, respectively. While
10% and 1% are also frequently used, the typical level of significance is 5%. (Brooks, 2008), the

37
model's signs illustrate the anticipated link between the dependent variable and the independent
variables. Last but not least, tables and graphs were used to illustrate all the data.

3.13. Data Presentation

After collecting the data relevant to the research through document review, the researcher edited
the data so as to avoid errors or omissions and Coding also done in such way that enables to
effectively categorize and analyses the data collected in stata software application. On the
other hand regression analysis, the most important part of the analysis, helps to identify and
determining variables effect and draw relationship between dependent and independent
variables. The panel regression findings were shown in tabular form and assessed using
individual statistical significance tests (T-tests) and overall statistical significance tests (F-test).
In order to determine if the assumptions of the classical linear regression model (CLRM) have
been broken or not, the researcher has also carried out diagnostic tests

38
 CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

This chapter deals with data analysis and interpretation. It has four major sections; the first
section deals about a descriptive statistics result, the second section tell us the correlation analysis
among the selected variables with bank liquidity. The third section is about statistical tests to
assure that Classical linear regression model‘s assumptions are held true. Finally, the OLS
regression result presented and discussed.

4.1. Summary of Descriptive Statistics.

The distribution of dependent and independent variables used in the study is explained by
descriptive statistics. The main idea of descriptive statistics for a given study is measurement of
location and variability. The central value of the variables denoted by location is measured mean
whereas the spread of the data from the mean denoted by variability is measured by standard
deviation. The dependent variable used in this study is liquidity (LIQ) (response
variable).whereas, Operational efficiency(OPEF),Deposit growth rate(DG),Gross Domestic
product (GDP), Reserve Requirement (RR), NBE-bills Purchase (NBE_bills), Bank size(BS),
Capital Adequacy(CAD),Profitability(ROA) and Asset Management(AM), are explanatory
variables.

Table 3 descriptive statistics of dependent and independent variables

LIQ BS CAD ROA AM OPEF DG GDP RR NBE-

bills

Mean 0.207 17.596 0.122 0.024 0.088 0.041 0.809 0.061 0.0315 0.161
Stand. Deviation 0.062 0.598 0.021 0.008. 0.109 0.007 0.107 0.151 0.008 0.021
Minimum 0.132 16.336 0.079 0.003 0.056 0.026 0.703 0.038 0.018 0.107
Maximum 0.395 19.027 0.178 0.049 0.845 0.062 1.281 0.084 0.047 0.232
Observation 50 50 50 50 50 50 50 50 50 50
Source: Owen computation from sampled audited financial statements and NBE from the year
2018 to 2022 G.C via stata

Table 3 shows the results of descriptive analysis of the current study for the period from 2018 to
2022. Bank‘s Liquidity is taken as a dependent variable, while the independent variables are bank

39
specific and macroeconomic factors. The mean value of liquidity (total liquid asset to total
customer deposit) of Ethiopian commercial Banks for a given period was 0.2071. The mean ratio
is by far, more than above the current minimum regulatory requirement of 15% (NBE Directives
No.SBB/57/2014).The maximum and minimum value of liquidity ratio is 39.5% and 13.2%
respectively. There is high variation of maximum and minimum liquidity ratio. However the
variation further indicated by standard deviation which is 6.2%. These mean as a general rule, the
higher the share of liquid assets in total assets, the higher the capacity to absorb liquidity shock,
given that market liquidity is the same for all banks in the sample. According to NBE Directives
No.SBB/57/2014 any licensed commercial banks in Ethiopia required to maintain not less than
liquid asset of 15% of its net current liabilities. All Ethiopian banks that have a liquidity ratio
below the minimum requirement need attention. In general the higher this ratio signifies that the
bank has the capacity to absorb liquidity shock and the lower ratio indicates the banks increased
sensitivity related to deposit withdrawal. Regarding the independent variables the table above
shows a descriptive summary statistic of different ratios.

Bank size, Natural logarithm of total asset is used as a measure of Bank size. The mean value of
Bank size is 17.596 which is the average total asset size of sampled commercial banks in Ethiopia
during the study period. Natural logarithm is employed to minimize deviations between maximum
and minimum values. The maximum and minimum total asset of the sampled bank in the given
period was 19.027 and 16.336 respectively. The standard deviation is 59.8 percent indicating
greater deviation or variability in factors affecting Ethiopian commercial banks liquidity.

As it is seen in the above table 3the average capital adequacy ratio of the sampled banks in the
study period is 12.27 % with the maximum and minimum CAD of 17.8 % and 7.9 %
respectively. The standard deviation of 2.142% for CAD reveals that, there was a big dispersion
towards the minimum capital adequacy ratio. The mean result of CAD implies above the
minimum requirement set by the NBE which is 8% NBE directive No SBB/05/2011. The higher
this ratio entails the capability of the bank to absorb losses from its own capital.

The profitability ratio which is measured by ROA is the independent variable with the mean
value of 0.024. The standard deviation of profitability is 0.008 from the mean value which is
the smallest standard deviation from its mean. The maximum and minimum value of

40
profitability ratio is 0.049 and 0.003 respectively. This indicates that there is small
profitability ratio of private commercial banks in Ethiopia during the study period.

The asset management ratio is peroxides by total operating income by total asset, has an average
value of 0. 889. The Standard deviation of all commercial banks asset management is 0.109 in
the study period as well as 0.056 and 0.845 minimum and maximum value respectively.

The mean value of Ethiopian commercial banks operational efficiency from 2018 to 2022 is
0.0414 with standard of 0.007 which is very small. Commercial banks of Ethiopia enjoyed 0.026
and 0.06.2 minimum and maximum value of operational efficiency in the given time period.

Deposit growth which is the independent variable with mean value of 0.809 showing standard
deviation of 0.107 from the mean value. The minimum value of deposit rate was 0.703 and the
maximum value of deposit rate was 1.281. This indicates that deposit growth of commercial
banks is very small as compared to liquidity of commercial banks this not leads to attract
customer deposit.

The other factor is external factor or macro-economic factors that affect commercial banks
liquidity. Real GDP growth rate is used as a measurement of GDP. In table 4, the mean of GDP
in Ethiopia during 2018-2022 of 6.14 percent, with a maximum 8.41 percent in 2022 and a
minimum of 3.81 percent in 2018 and the standard deviation of 1.52 percent during the period
the study period.

Reserve Requirements ratio is measured using total deposit with NBE by total assets and its
value ranges from a minimum of 1.8 percent to maximum of 4.7 percent with a mean value and
standard deviation of 0.0315and 0.008 respectively. Mean is less that (7%) NBE SBB/84/2022.

The mean of NBE-bills measured by total amount of NBE-bills purchased by the bank divided to
total assets was 0.1619 with the minimum and the maximum of 0.107 and 0.2321, respectively.
However, its standard deviations were very small which 0.0219%.

4.2. Correlation Analysis

It is common conducting correlation analysis among variables before going to do detail
regression analysis. Correlation analysis is used to identify the direction of relationship between
two variables and to measure the degree of association between them. The value of correlation
lies between +1 and -1. A correlation coefficient close to either –1 or +1 indicates that there was

41
strong inverse or direct relationship between variables respectively; whereas a correlation
coefficient of zero indicates that the variables are uncorrelated (Brooks, 2008). Correlation
analysis is conducted in this section in order to analyze and examine the relationship between
variables

Table 4 Correlation Analysis

LIQ BS CAD ROA AM OPEF DG GDP RR NBE-bills

LIQ 1.0000

BS -0.4306 1.000

CAD 0.3515 -0.4177 1.000

ROA 0.4055 -0.0688 0.6095 1.000

AM 0.0065 0.1881 0.967 0.1535 1.000

OPEF -0.2453 0.3294 -0.4309 -0.5100 -0.0412 1.000

DG 0.1091 -0.2115 -0.1300 0.0216 -0.0367 -0.2872 1.000

GDP -0.1346 -0.4764 0.0192 0.0189 -0.0343 -0.2934 0.1898 1.000

RR 0.1796 -0.3493 0.7126 0.3394 0.0972 -0.1560 -0.2032 0.0077 1.000

-0.1884
NBE-bill -0.5013 0.5166 -0.1452 -0.1443 0.699 0.1818 -0.3907 0.1800 1.0000
Source: Owen computation from sampled audited financial statements and NBE from the year
2018 to 2022 G.C via stata

As it is seen from the above Table 4 the correlation coefficient of bank size, operational
efficiency, real gross domestic product and National bank bills purchase is negatively correlated
with liquidity of commercial banks in the given study period. This indicates that as of bank size,
operational efficiency, real gross domestic product and National bank bills purchases increase
liquidity of commercial banks decrease. The correlation coefficient of capital adequacy,
profitability ratio, asset management, deposit growth and reserve requirements is positively
correlated with liquidity. This indicates that as capital adequacy, profitability ratio, asset
management, deposit growth and reserve requirements increase there is also increasing of bank
liquidity.

The correlation coefficient between profitability and liquidity is 0.4055 it means that there was
strongly positive correlation between profitability and liquidity of commercial banks, whereas
the correlation coefficient between asset Management and liquidity was 0.0065 which is the

42
weakest positive correlation among the listed variables. The correlation coefficient between NBE
bills purchase and liquidity is -0.5013 this reveals that there is strong negative correlation
between NBE bills purchase and bank liquidity but the correlation coefficient between gross
domestic product and liquidity was -0.1346, it depicts that weakly negative relation between
them.

4.3. Diagnostic tests of Classical Linear Regression Model (CLRM)

The classical linear regression model assumptions hold true, then the estimators determined by
ordinary least square (OLS) will have a number of desirable properties which is known as Best
Linear Unbiased Estimators (BLUE) (Brooks, 2008), Hence, the following sections discuss
about the result of diagnostic test including, Multi-collinearity, Heteroskedasticity, normality,
autocorrelation, unit root test, model specification test and model selection to ensure whether the
data fits the basic assumptions of classical linear regression model or not.

4.3.1. Heteroskedasticity Test

Homoscedastic error term is one of the classical assumptions required for the OLS estimator to
be efficient. The homoscedastic assumption fulfilled when the variance of disturbance term is
constant and the same for all observation. If the disturbance terms do not have a constant
variance across all observations the assumption of Homoscedastic will be violated. The violation
of this assumption said to be Heteroskedasticity. If the problem Heteroskedasticity exists in the
model, the least squares estimators are still unbiased(consistent) however the Gauss- Markov
theorem was violated, in other words confidence interval will be unnecessary larger. As result,
the t-test and f-test gives inaccurate result because of overestimation of variance, the t-test will
be smaller and statistically insignificant which leads to wrong conclusion (Gujarati, D. N. &
Porter, D. C.,, 2009). There are several tests present to detect the violation of this assumption.
This study used Breusch-pagan test in order to check the presence of the problem of
Heteroskedasticity for this model. The hypotheses for test of Heteroskedasticity were
formulated as follows.

HO: There is homoscedasticity/constant variance/no Heteroskedasticity

H1: There is Heteroskedasticity.

Decision rule:

43
Reject Ho if p-value is less than the significant level (α = 5%). Otherwise, do not reject Ho

Table 5 Heteroskedasticity Test

Breusch-Pagan / Cook-Weisberg test for Heteroskedasticity

Ho: Constant variance

Variables: fitted values of liq

chi2(1) 2.83

Prob > chi2 0.0925

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

As it is indicated in the above table 5 the probability value of chi2 is 0.0925 or 9.25% which is
higher than normal acceptance of significant level of 5%. Therefore, the null hypothesis of
homoscedasticity is failed to reject at 5 percent level of significant. In other words, there is no
Heteroskedasticity in this research model, so we can run OLS to this research model.

In econometrics, an extremely common test for Heteroskedasticity is the White test, which is a
statistical test that establishes whether the variance of errors in a regression model is constant,
which is homoscedasticity. If no cross product terms are introduced in the white test procedure,
then this is a test of pure Heteroskedasticity.

44
 Figure 2.Test of Heteroskedasticity by White test

. estat imtest,white

White's test for Ho: homoskedasticity

against Ha: unrestricted heteroskedasticity

chi2(49) = 50.00
Prob > chi2 = 0.4334

Cameron & Trivedi's decomposition of IM-test

Source chi2 df p

Heteroskedasticity 50.00 49 0.4334

Skewness 17.76 9 0.0380
Kurtosis 0.03 1 0.8671

Total 67.79 59 0.2025

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

From the above figure under white test the probability value of chi2 is 43.34%, which is greater
than 5% of significance level. This indicates that the null hypothesis fail to reject. In other words,
there was no Heteroskedasticity in this research model. With respect to Skewness the probability
value is 3.80% and the probability value of kurtosis is 86.71 % which is greater than 5% of
significance level. This implies that there is no significance evidence for the presence of
Heteroskedasticity at 5% significance.

4.3.2. Test of Normality

A normal distribution is not skewed and is defined to have a coefficient of kurtosis of 3. A
distribution said to be normal when it is symmetric about its mean and also called mesokurtic,
while a skewed distribution is not symmetric to its mean, it may be skewed to the left or right
side of its mean. For this research to cheek the problem of normality test, the researcher has
been conducted using the most popular test of normality, Shapiro-Wilk W test for normal data.
Based on this test of Normality, if the P value is more than 0.05 (P ≥ 0.05) there is no normality
problem.

Shapiro-wilk W test for normal data

45
Table 6 Test of normality

Variable Observation W V Z Prob>z

Res 50 0.97891 0.992 -0.017 0.50698

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

The hypothesis for normality test was formulated as follows

Ho: Error term is normally distributed

H1: Error term is not normally distributed

Decision rule: reject Ho if p-value of Shapiro-Wilk W is less than the significant level (α = 5%).
Otherwise, do not reject Ho.

Therefore, the normality tests for this study as shown in table 6, above , the Shapiro-Wilk W test
for normal data has a P-value of 0.50698 implies that the p-value of the Shapiro-Wilk W test for
normal data for the models is greater than 0.05 which indicates that the errors are normally
distributed. From the above table the probability value of normality test is 50.698% which is
greater than 5% significant level that shows we fail to reject the null hypothesis.

4.3.3. Multicolinearity Test

According to Brooks (2008), Multicolinearity is the statistical term used for the problem that
arises due to high correlations among the independent variables in multiple regression models. It
is caused by independent variable having common information. The presences of highly
correlated independent variable prevent us from obtaining insight into the true contribution to the
regression from each of the independent variables. As noted by (Gujarat, 2004) a serious
problem for multi co-linearity is occurred if the correlation is above 0.8 or that is pair-wise or
zero-order coefficient between independent variable is out of the recommended range of multi
co-linearity, which is -0.8 or 0.8.While Hair (2006), argued that correlation coefficient below 0.9
may not cause serious multi co-linearity problem.

The standard statistical method for testing data for multi co-linearity is analyzing by variance
inflation factor (VIF) and explanatory variables correlation coefficients. The benchmark for
variance inflation factor (VIF) often given as 10.Thus, if variance inflation factor (VIF) of
explanatory variable exceeds 10 indicates that there is the presence of multi co-linearity. If the

46
variance inflation factor (VIF) of explanatory variable less than 10 indicates that, there is
absence of multi co-linearity.

Table 7. Multi-collinearity test by variance inflation factor

Variable VIF 1/VIF

CAD 3.97 0.251788

RR 2.24 0.308826

BS 3.08 0.324449

ROA 2.24 0.447242

NBE-bills 2.18 0.458691

OPEF 1.89 0.654021

GDP 1.54 0.648094

DG 1.33 0.754498

AM 1.11 0.898786

Mean VIF 2.29

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

From the above table 7, the variance inflation factor (VIF) of all independent variables are less
than 10.This showed that there is no Multicollinearity problem between explanatory variables.

4.3.4 .Test for Autocorrelation

Another assumption of the classical linear regression model is that the covariance between the
error terms over the time or cross-sectional is zero. In other terms, it is assumed that the errors
are uncorrelated with one another. In this regard to test this assumption, the Wooldridge test for
autocorrelation in panel data serial correlation test was used. The hypothesis for test of
autocorrelation was formulated as follows.

HO: There is no autocorrelation

47
 H1: There is autocorrelation
Table 8.Test for Autocorrelation

Wooldridge test for autocorrelation in panel data

H0: no first order autocorrelation

F( 1, 9) = 4.827

Prob > F 0.0556

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

Decision rule:
Reject Ho if p-value is less than the significant level (α = 5%). Otherwise,
Do not reject Ho.
From the above table 8, under Wooldridge test for autocorrelation the probability value of F
is 5.56 % which is greater than 5% significance level. This depicts that we fail to reject the
null hypothesis. This means that there is no significance evidence for the presence of
autocorrelation at 5% significance level in this research model.

4.3.5. Test for Model Specification: Ramsey RESET Tests

Model specification is one of classical linear regression model (CLRM) that the regression
model used in the analysis should be correctly specified: If the model is not specified correctly,
we encounter the problem of model specification error or model misspecification. Model
specification error occurs when omitting an important independent variable, or including
unnecessary variable or choosing wrong functional form. If the omitting variable is correlated
with the variable which included, the estimators will be biased and inconsistent and model
specification error will tends to occur as noted by (Gujarat, 2004). To test this assumption,
Ramsey RESET test was used. The hypotheses for model specification test were formulated as
follows.

48
Table 9.Test for Model Specification: Ramsey RESET Tests

Ramsey RESET test using powers of the fitted values of liq

Ho: model has no omitted variables

F(3, 37) 2.21

Prob > F 0.0826

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

The hypotheses for model specification test were formulated as follows.

HO: There is no omitting variable or model specification is correct

H1: There is omitting variable or model specification is incorrect

Decision rule: reject Ho if p-value is less than the significant level (α = 5%). Otherwise, do
not reject Ho

As it is shown in the above table 9, the Ramsey RESET test F-statistics is 2.21 with p-value of
0.0826 which is greater than 5% significant level, so we failed to reject the null at 5% significant.
Therefore, it depict that this model is correctly specified and the estimated coefficients are
appropriate to explain the liquidity factors.

4.3.6. Random Effect vs. Fixed Effect Models

According to (Brooks, 2008), there are broadly two classes of panel estimators‘ approach models
that can be applied in financial research that is fixed effect model and random effect models.
Choosing one of the two models depends on the assumption we make about the likely correlation
between the cross-sections specification error and explanatory variable are uncorrelated.
Hausman test is used to choose appropriate model for the study. The hypotheses for model
selection were formulated as follows.

HO: random effect model is appropriate

H1: fixed effect model is appropriate

Decision rule: reject Ho if p-value is less than the significant level (α = 5%). Otherwise do not
reject Ho.

49
Figure 3.Random effect vs. fixed effect model models

. hausman fixed random

Coefficients
(b) (B) (b-B) sqrt(diag(V_b-V_B))
fixed random Difference S.E.

bs -.1167131 -.0495665 -.0671466 .0264395

cad -.7338331 -.8850653 .1512322 .407263
roa 1.374792 2.789972 -1.41518 .4879633
am -.0105996 .0342033 -.0448028 .
opef -.7575139 -.4592552 -.2982586 1.032172
dg .1868353 .0205938 .1662415 .0621971
gdp -3.12392 -2.377937 -.7459828 .3145869
rr -3.489488 1.348304 -4.837792 1.848945
nbebills -.0600794 -1.406839 1.346759 .3240777

b = consistent under Ho and Ha; obtained from xtreg

B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(9) = (b-B)'[(V_b-V_B)^(-1)](b-B)
= 5.65
Prob>chi2 = 0.7742
(V_b-V_B is not positive definite)

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

Therefore, the researcher made Hausman test for these models to check whether to use fixed
effects or random effects model. Random effects model is found to be appropriate. Based on the
Hausman model specification test, the P- value of the model is 0.7742 or 77.42% which is more
than 5% level of significance. This showed that the null hypothesis of the model which is
Random effect model is appropriate failed to reject at 5 percent of significant level.

Therefore, Random effect model is appropriate for this study and regression analysis will be
made based on random effect estimates.

liq [b,t] = Xb + u[b] + e[b,t]

50
Table 10.Breusch and Pagan Lagrangian multiplier test for random effects

Breusch and Pagan Lagrangian multiplier test for

random effects

chibar2(01) 0.00

Prob > chibar2 1.0000

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

After running the Hausman test, it is better to test Breusch and Pagan Lagrange multiplier for
random effects versus pooled ordinary least square method. The LM test (Lagrange Multiplier
test) is used to decide between a random effect‘s regression and simple OLS regression. The null
hypothesis is that there is no significant different across cross-sectional unites (i.e. no panel
effect) implying that random effects model is inappropriate. Based on the above table 10, The
LM test statistics is 0.00 for the Model with the p-value of 1.000 which is greater than 5 percent,
so it is insignificant and the null hypothesis in favor of OLS is fail to reject. Thus, the pooled
ordinary least square is chosen against Random effects model.

4.3. Regression Analysis and Interpretation

The operational panel regression model used to find the statistically significant factors affecting
liquidity of commercial banks Ethiopia was:

LIQ=βo+β1(BSit)+β2(CADit)β3(ROAit))+β4(AMit)+β5(OPEFit)+β6(DGit)+β7(RRit)β8(G
DPt)+β9((NBEbillit)+Uit

Where,

LIQ it = is liquidity ratio measured by Liquidity for ith bank on year t.

BS it=Bank size of bank i at time t.

CAD it=Capital adequacy of bank i at time t

ROA it=profitability of bank I at time t

AM it=asset management for bank i at time t.

OPEF it=operation efficiency for bank i at time t.

DG it=deposit growth rate of bank i at time t

51
GDP t=real gross domestic product/GDP growth of Ethiopia on the year t.

RR it=Reserve requirement of bank i at time t

NBE-bill it=is national bank bill purchase for bank i at time t.

U it = is a random error term

Figure 4.Regression result by OLS

Source SS df MS Number of obs = 50

F(9, 40) = 7.65
Model .122042201 9 .013560245 Prob > F = 0.0000
Residual .07093347 40 .001773337 R-squared = 0.6324
Adj R-squared = 0.5497
Total .192975671 49 .003938279 Root MSE = .04211

liq Coef. Std. Err. t P>|t| [95% Conf. Interval]

bs -.0495665 .0176595 -2.81 0.008 -.0852576 -.0138754

cad -.8850653 .5594674 -1.58 0.122 -2.015791 .2456605
roa 2.789972 1.006202 2.77 0.008 .7563627 4.823582
am .0342033 .0579882 0.59 0.559 -.0829952 .1514018
opef -.4592552 1.077865 -0.43 0.672 -2.637703 1.719192
dg .0205938 .0646476 0.32 0.752 -.110064 .1512515
gdp -2.377937 .4918208 -4.83 0.000 -3.371944 -1.38393
rr 1.348304 1.288964 1.05 0.302 -1.256789 3.953398
nbebills -1.406839 .4055274 -3.47 0.001 -2.22644 -.5872372
_cons 1.449856 .339907 4.27 0.000 .7628779 2.136833

Source: Computed through Stata, NBE and Banks audited annual report from 2018-2022

The above figure 4 depicts the effect of independent variables on commercial banks liquidity.
Thus liquidity is the dependent variable while bank size, capital adequacy, profitability, asset
Management, Operational efficiency, deposit growth rate, gross domestic product, Reserve
requirement and NBE-bill purchases are independent variables.

Multiple regression analysis was conducted to establish the relationship between commercial
banks liquidity and the independent variables. The OLS model equation which is applied in this
thesis is as follows:

LIQ=1.4498-0.0495BS-0.8850CAD+2.7899ROA+0.03420AM-0.4592OPEF+0.0205DG-
2.3779GDP-1.3483RR-1.0468NBEbillit+Uit

4.3.1. Interpretation of F- Statistic/variance Test/Model fit test

According to the above figure 4, the overall, F-statistic 7.65 which is highly significant at 1%
with a p-value 0.000 revealed that, those independent variables collectively have statistically

52
significant effect on the dependent variable. Thus, it implies that the explanatory variables in the
model can describe the variations in the dependent variable, in which the total model is
significant and we can use these data for prediction, policy making and educational purpose.

4.3.2. Interpretation of Coefficient of Determination(R- squared)

The coefficient of determination measures the success of the regression in predicting the values
of dependent variable in the sample. It is the contribution of the independent variables to
dependent variable. As noted by Muijs (2004), there is a rule of thumb, which can be used to
determine the R – squared values as follows: 0% to 10% poor fit, 11% to 30% week fit, 31% to
50 % moderate fit, and greater than 50% strong fit. The result of regression in the above figure
shows, R2 is 63.24%, meaning that 63.24% variation of the dependent variable is explained by
the selected independent variables. In other words (100% - 63.24% = 36.76%) change in the
dependent variable is due to unknown variables or error variables. It means that explained
variance is more than error variance, which is good sign for developing the model.

4.3.3. Interpretation of Adjusted R – Squared

The adjusted R – squared tells that whether the additional independent variable contributed to the
total model or not. Only when the additional term enhances the model more than would be
predicted by chance does the modified R2 rise. It falls off when a predictor boosts the model by
less than would be predicted by chance. Here in this study adjusted R2 of 54.97% indicates
that the formula is strongly fit for predicting the dependent variable liquidity. These means
that 54.97% of changes occur in the dependent variable liquidity are attributable by the
explanatory variable.

4.3.4. Interpretation of Regression Result

In this section, the relationship between dependent variable and each explanatory variable on the
basis of findings were explained. The study includes the dependent variable which is liquidity
and the independent variables, bank size, capital adequacy, Profitability, Asset Management,
Operational efficiency, deposit growth rate, Gross Domestic Product, Reserve requirement and
NBE-bill purchases.

53
 4.3.5. Interpretation of Intercept (Constant)
The constant is often defined as the value of the dependent variable when you set all of the
explanatory variables in the model to zero. Here, from the above figure the value of intercept is
1.4498 and probability value of 0.000 that is significant even at 1%. This indicates that when all
value of the independent variable is equal to zero the dependent value is equal to 1.4498.

4.4. Discussion of Regression Results

4.4.1. Interpretation of Bank Size

According to the above figure 4, bank size has negative and significant effect on liquidity of
commercial banks in Ethiopia during the study period. The regression result found to be negative
and statistically significant result on liquidity. The coefficient value of the Bank size is -
0.0495665 with p value of 0.008 which revealed, a unit increases in Bank size or total asset in
commercial banks, results 0.0495665 decrease in liquidity of commercial banks in Ethiopia
holding other variables constant, but it is statistically significant even at 1% confidence level.
This outcome is similar with the study conducted by (Wubayehu, 2017)and (Rahel, 2019) and
Eissa A. Al-Homaidi1 et al. (2019), which suggested as BS has negative statistically significant
effect on commercial banks liquidity. However, the findings of the current study is inconsistent
with that of Aspachs et al. (2005) who have suggested that bank size has an insignificant
influence on LQD.

4.4.2. Interpretation of Capital Adequacy Ratio

Capital adequacy which is measured by the ratio of equity and reserve to total asset is positively
related with LIQ of commercial banks and has statistically insignificant effect, with p-value of
0.122 and estimates of coefficient is -0.8850653 respectively. As it is revealed in figure 4, the
negative coefficient of CAD indicated that, holding other variables constant one unit increases
in capital adequacy results, 0.8850653 unit decrease in liquidity of Ethiopian commercial banks
and this is in line with the findings of wassihune (2020); Laurine (2013) and Diamond DW and
Rajan RG(2000,2001 ), the result also showed that it has negative and statistically insignificant
impact with liquidity which is inconsistent with the study provided by Nigist (2015) and
Tseganesh (2012) .

54
 4.4.3. Interpretation of Profitability Ratio
The above OLS Regression model shows that, profitability ratio has positive and statistically
significant impact on liquidity of Ethiopian commercial banks. This positive relation shows that,
higher profitability leads to increase banks liquidity. Hence, the profitability ratio has the
coefficient of estimate of 2.789972, t – value of 2.77 and its probability value of 0.008 indicated
that profitability ratio has statistically significant result even at 1% significance level. The
coefficient of estimate implies that holding other explanatory variable constant, when the
profitability ratio increase by one percent 1, liquidity of commercial banks increase by 2.789972.
Here the result of the study agreed with my expectation stated on hypothesis. In general, the result
of this study was consistent with the findings of (Vodova, 2012) and Rahel (2019), but opposite
to Tiesset, (2006) and (Nigist, 2015), claimed that profitability had negatively affected bank‘s
liquidity Thus, the researcher concluded that profitability ratio has a positive and statistically
significant effect on liquidity of commercial banks in Ethiopia during the study period.

4.4.4. Interpretation of Asset Management

The regression result shows that, asset management has positive and insignificant effect on
liquidity of commercial banks in Ethiopia. Hence, Asset Management has the coefficient
estimate of 0.0342033, t – value of 0.59 and its probability value of 0.559.The p-value of 0.559
showed that it is statistical insignificant even at 10% significance level. Whereas coefficient
estimate of 0.0342033 implies that holding other explanatory variable constant, when the asset
management of commercial banks of Ethiopia increases by one unit, liquidity of commercial
banks also increase by 0.0342033 Thus, we concluded that asset management has a positive
and insignificant effect on liquidity of commercial banks in Ethiopia.
This study is consistent with the previous studies of Eissa A. Al‐Homaidi et al, (2019) so that the
result suggested that when Asset Management increases the liquidity of commercial banks of
Ethiopia increases.

4.4.5. Interpretation of Operational Efficiency

From the above figure 4, the operational efficiency has negative and insignificant effect on
liquidity of commercial banks in Ethiopia. Hence, the operating efficiency has the coefficient
estimate of -0.4592552, t – value of -0.43 and its probability value of 0.672. Its probability value
0.672 revealed that it is statistical insignificant at 5% significance level. The inverse relationship

55
between them implies that holding other explanatory variable constant, when the operating
efficiency increase by one unit, liquidity of Ethiopian commercial banks decreases by 0.4592.
The study consistent with my expectation since its effect was statistically insignificant as well as
negative relationship. Thus, we concluded that operational efficiency has a negative and
statistically insignificant effect on Ethiopian commercial banks in the study period.
This result is consistent with the previous studies of Eissa A. Al‐Homaidi et, al (2019), so that
the result suggested that when operational efficiency increases the liquidity commercial banks of
Ethiopia decrease.

4.4.6. Interpretation of Deposit Growth

As it is evident in the above figure, deposit growth has a positive and insignificant effect on
liquidity of commercial banks in Ethiopia. Hence, the deposit growth has the coefficient of
estimate of 0.0205938, t – value of 0.32 and its probability value of 0.752 depicted that deposit
growth is statistical insignificant even at 10% significance level with coefficient of estimate of
0.0205938 that implies holding other explanatory variables constant, when the deposit growth
increase by 1 unit liquidity of commercial banks also increase by 0.0205938. This result is
similar with the study conducted by Wubayehu, (2019).

4.4.7. Interpretation of Gross Domestic Product

As it is depicted in the above regression figure 4, GDP has -2.377937 coefficient of estimate, t-
value of -4.83 and p-value of 0.000.The probability value shown in the figure implies GDP is
statistically significant even at 1% level of significance. The coefficient of GDP being negative
revealed that as GDP increase by one unit liquidity of commercial banks decrease by 2.377937.
This result is consistent with Valla et al. (2006), Dinger (2009), (Vodova, 2011) and (Aspachs et.
al. and Tiesset, 2005), which established negative relationships between the liquidity and GDP.
This implies that in a recession of the economy commercial banks is more liquid than in the
boom time. Hence, the result is similar with the hypothesis stating; real GDP growth rate has
negative and significant impact on banks liquidity.

4.4.8. Interpretation Reserve Requirement

As it is seen in the above figure 4, the obligatory reserve has estimates of coefficient, t-value and
p-value of 1.348304, 1.05, and 0.302 respectively. RR p-value revealed that it is statically
insignificant at 5% significant level whereas, estimates of coefficient 1.348304, indicating that as

56
reserve requirement increase by one unit having other explanatory variables constant liquidity of
commercial banks of Ethiopian increase by 1.348304. Indeed, the reserve requirement held by
NBE is for reliability issue for depositors and it has positive impact on the banks liquidity.
Liquidity will increase when customers deposit increases commercial banks of Ethiopian in the
forms of demand deposit saving deposit and time deposit, similarly RR increase by 7% for every
colander month. This result is inconsistent with the previous studies conducted by Rahel (2019).

4.4.9. Interpretation of National Bank bill and Liquidity

The regression result stated in figure 4, investment in NBE-Bills measured by NBE bill purchase
to total asset is negatively related with liquidity of commercial banks in Ethiopia. As it is
depicted in the above table p-value, t-value and coefficient estimate of NBE-bill purchase is
0.001, -3.47 and -1.406839 respectively. NBE bill purchase has a coefficient estimate of -
1.406839 means, holding other factors constant, 1 unit increase in NBE bill will decrease
liquidity of commercial banks in Ethiopia by 1.406839 and its p-value 0.001 revealed that it is
statistically significant even at 1 percent level of significance. This study is consistent with the
researchers‘ prior expectation, like Rahel (2019) ,Wubayehu (2017) and Belet (2015),which
forces banks to invest 27 percent of total loans disbursed on bonds (NBE Bills) on which banks
have no right to use it for payment and settlement purposes when the need arises. For 1 birr loan
and advance to customer they must purchase 27 cents of national bill, Hence, the hypothesis
stating NBE Bill has negative and significant impact on bank liquidity should be accepted.

57
 4.5. Summary of Analysis
Table 11 summary of analysis

s.no Explanatory Expected sign and Actual impact on liquidity Decision

variables impact on liquidity

1 BS Negative significant Negative and significant Accepted

2 CAD Positive significant Negative and insignificant Rejected

3 ROA Positive significant Positive and insignificant Rejected

4 AM Positive insignificant Negative and insignificant Rejected

5 OPEF Negative insignificant Negative and insignificant Accepted

6 DG Positive significant Negative and insignificant Rejected

7 GDP Negative significant Negative and significant Accepted

8 RR Negative significant Positive and insignificant Rejected

9 NBE-bills Negative significant Negative and significant Accepted

58
 CHAPTER FIVE
SUMMARY OF FINDINGS, CONCLUSION, AND
RECOMMANDATIONS

5.1. Introduction
This chapter consists of summary of finding, conclusions, recommendations and an indication
of future researches. Since the study deals about the factors that affects liquidity in Ethiopia
Commercial banks during the period from 2018-2022 G.C. Findings indicated that Ethiopian
commercial banks liquidity are influenced by bank specific or internal factors including: Bank
size (BS), Capital Adequacy (CAD), Profitability (ROA), Asset Management (AM),
operational efficiency(OPEF),deposit growth (DG) and external or macroeconomic factors
including: Gross domestic product (GDP),Reserve requirement(RR) and NBE-bill
purchases(NBE-bills) .This chapter outlines the summary and conclusions of the study in
accordance with the regression results. It also gives an insight on the policy recommendations
as well as suggestions for future studies.

5.2. Summary of Findings

The thrust of the study was in investigating the factors affecting liquidity in selected
commercial banks operating in Ethiopia. An explanatory research design adopted to explain
the casual relationships between the variables. The study employed quantitative methods on
secondary data sourced from audited financial statements of banks, NBE publications for
macro-economic variables as well as from World Bank. Banks should remain liquid at all
times to prevent falling into liquidity crisis, which cause distress among the stakeholders and
tremor in the overall economy. Thus, this study attempts to identify the factors affecting
liquidity of selected private commercial banks in Ethiopia. This research also provides
summary of previous studies on similar topics. Nine variables affecting the selected private
commercial banks liquidity were chosen and analyzed. Panel data was used for the sample of
ten commercial banks in Ethiopia from the year 2018 to 2022 GC and estimate using Random
effect model (REM). Data was presented by using descriptive statistics. The balanced

59
correlation and regression analysis for liquidity conducted. Before performing OLS regression
the models were tested for the classical linear regression model assumptions. Analysis made
for nine factors affecting selected private commercial banks liquidity. From the list of
possible explanatory variables, bank size, profitability, gross domestic product and NBE-bill
purchase proved to be statistically significant at 5% significant level whereas the rest are not
statistically significant at 5% but positively or negatively affects at different significant or
confidential level.

The specific findings on each of the factors are presented below as follows:

 Bank size has a negative and statistically significant effect on liquidity of Ethiopian
commercial banks at 5 % level of significance. So bank size has inverse relationship
with liquidity.
 Capital adequacy ratio has a negative and insignificant impact on liquidity of
commercial banks in Ethiopia. This indicates that as capital adequacy ratio of the
bank increase liquidity position of Ethiopian commercial banks decreases, more
liquidity problem will happen.
 Profitability ratio has a positive and significant effect on liquidity of commercial
banks in Ethiopia, So that as profitability of Ethiopian commercial banks increase
liquidity position of the bank also increases. i.e. directly related.
 Asset management ratio has a positive and insignificant impact on Ethiopian
commercial banks liquidity. This means that statistically asset management has
insignificant effect on Ethiopian commercial banks liquidity with positive
relationship.
 Operational efficiency has a negative and insignificance impact on commercial banks
of Ethiopia at 5% and 1% significance level even at 10% significance level, And
OPEF related negatively with liquidity.
 The relationship between deposit growth and bank liquidity is positive, as deposit
growth increase liquidity of commercial banks also increase but statistically deposit
growth has insignificant effect.
 Real GDP Growth rate has negative impact on the liquidity of commercial banks and
it is statistically significant even at 1% significance level. Since as growth domestic
product of the country increases liquidity position of commercial banks decreases.
60
 The statistically significant effect of real GDP growth rate on commercial banks‟
liquidity was properly aligned to Angora and Roulet (2011) and Cucinelli (2013).
 Liquidity is positively influenced by reserve requirement and Reserve requirement
has statistically insignificant impact even at 5% significance level. The positive
relationship between the reserve requirement and banks liquidity indicates that as
Reserve requirement increase also liquidity of commercial banks increase by
estimates of coefficient.
 NBE bill Purchase has negative and statistically significant impact on the
determination of liquidity of Ethiopian commercial banks and it was in line with the
hypothesis.it depicts that statistically it is significant for liquidity determination,
which is consistent with the researchers conducted by Rahel (2019). Based on the
results from the regression analysis estimated by random effect regression model the
following conclusions was made

5.3. Conclusion
The study finally concluded that the factors affecting liquidity of commercial banks‘ of
Ethiopia are bank specific/internal factors/ that includes bank size ratio, capital adequacy
ratio, profitability ratio, Asset management, operational efficiency, deposit growth and
external/ macroeconomic factors/ includes Gross domestic product, Reserve requirement and
NBE-bills purchase. Among the aforementioned variables, bank size, profitability ratio gross
domestic product and NBE-bills purchase has statistically significant impact on determination
of commercial banks liquidity. But, Asset management, operational efficiency, capital
adequacy ratio, operational efficiency, deposit growth and Reserve requirement has
statistically insignificant effect on determining liquidity of Ethiopian commercial banks
during the sampled period.

5.4. Recommendations
Based on the finding and conclusion the study, the research forwards these recommendations to
Ethiopia‘s commercial banks,

 As depicted in the finding Bank size was negatively related with liquidity of commercial
bank in Ethiopia and statistically significant. For that matter, bank size has statistically

61
 significant effect can be taken as the major factors of banks liquidity in this study. Since
the size of the bank can be assessed interms of total asset, deposit, total liability and
capital. As bank size increase business organization wants mostly to invest its asset on
illiquid asset, but for this investment concerned body should know that liquidity buffer of
banks is obligatory.
 Capital adequacy: While issuing new directives or amending the existing policies, NBE
take into consideration that the increase of capital requirement has stood pressure on the
banks liquidity. Since capital requirement has negative and insignificant impact on banks
liquidity.
 Concerning with profitability ratio, it has a positive and significant effect on liquidity of
Ethiopian commercial banks as it was revealed in the finding. Following this, the
researcher recommended that banks increase their profitability by putting high loan to
Borrowers and can get high interest income but it should be consider the relationship with
their borrowers due to unable to pay their loans and the occurrence of NPL because this
NPL negatively affects liquidity position of Ethiopian commercial banks.
 With respect to Asset management and operational efficiency, liquidity of Ethiopian
commercial banks affected negatively but statistically insignificant so that managers,
boards and all staffs should manage banks asset carefully and controllable and non-
controllable expense should allocated and expensed in a responsible manner.
 Deposit growth: This finding implies that with an increase in customers deposits, banks
liquidity position also increase as results, if banks holds more liquid asset which is idle
leads a bank to more problems, so concerned body should take care of it.
 As it is seen in the finding and conclusion GDP has negative effect on bank liquidity and
statistically significant so concerned bodies like national bank of Ethiopia and Ethiopian
government should be made all rounded inspection concerning financial institution
activity and the country‘s economic condition by considering different aspects.
 While issuing new directives or amending the existing policies, NBE and government of
Ethiopia take into consider that the increase of statutory reserve requirements policy has
stood pressure on the banks liquidity even it has positive relationship. At first huge
amount of liquid asset should not deposit at NBE especially at this time while liquidity
problem is bottleneck throughout the country.

62
  NBE Bill purchase: Since huge amount of loanable fund from the commercial banks is
tied up in NBE with very small interest rate which is three percent and as it contributes
negatively to the commercial banks liquidity. NBE should revise the policy by either
increasing the interest rate provided on the bill purchase or to decrease the percentage of
obligatory bill purchase by the commercial banks. Since it has still gaps when we
compare it with the deposit rate of 7%.

5.5. Suggestion for Future Study

The major emphasis of this study was on factors affecting liquidity of selected commercial
banks in Ethiopia using some selected variables. However, there are so many internal or
bank specific factors and external or Macroeconomic factors that affects liquidity of
commercial banks in Ethiopia like service quality of the bank, asset quality of the bank ,non-
performing loan, interest rate, inflation rate etc. So by using the above listed factors future
studies can be conducted on this area to improving knowledge

63
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APPENDEX 1
Bank Year LIQ BS CAD ROA AM OPEF DG GDP RR NBE-bills

AB 2018 0.268 17.828 0.118 0.031 0.071 0.035 0.786 0.068 0.040 0.152

AB 2019 0.191 18.128 0.129 0.037 0.080 0.034 0.799 0.084 0.039 0.169

AB 2020 0.205 18.307 0.134 0.032 0.845 0.038 0.791 0.061 0.036 0.171

AB 2021 0.175 18.673 0.123 0.031 0.081 0.040 0.795 0.056 0.032 0.181

AB 2022 0.217 19.027 0.114 0.034 0.089 0.043 0.807 0.038 0.030 0.187

DB 2018 0.196 17.632 0.130 0.020 0.060 0.037 0.790 0.068 0.020 0.137

DB 2019 0.132 17.845 0.122 0.018 0.063 0.041 0.800 0.084 0.018 0.155

DB 2020 0.163 18.039 0.122 0.025 0.069 0.043 0.780 0.061 0.025 0.166

DB 2021 0.149 18.366 0.107 0.021 0.065 0.037 0.790 0.056 0.021 0.176

DB 2022 0.185 18.579 0.123 0.028 0.074 0.039 0.780 0.038 0.028 0.172

BOA 2018 0.174 17.281 0.133 0.017 0.069 0.042 0.807 0.068 0.027 0.151

BOA 2019 0.139 17.487 0.126 0.020 0.071 0.041 0.818 0.084 0.030 0.161

BOA 2020 0.134 17.857 0.100 0.018 0.068 0.047 0.837 0.061 0.024 0.175

BOA 2021 0.136 18.461 0.083 0.017 0.072 0.044 0.856 0.056 0.019 0.196

BOA 2022 0.151 18.822 0.095 0.028 0.084 0.048 0.817 0.038 0.022 0.201

WB 2018 0.197 17.126 0.140 0.029 0.085 0.044 0.733 0.068 0.041 0.146

WB 2019 0.182 17.209 0.144 0.029 0.072 0.046 0.773 0.084 0.045 0.156

WB 2020 0.211 17.457 0.134 0.024 0.083 0.050 0.767 0.061 0.043 0.165

WB 2021 0.154 17.496 0.127 0.003 0.089 0.062 0.746 0.056 0.046 0.177

WB 2022 0.304 17.579 0.130 0.013 0.073 0.061 0.737 0.038 0.045 0.181

HB 2018 0.196 17.149 0.105 0.020 0.067 0.057 0.705 0.068 0.028 0.143

70
HB 2019 0.132 17.392 0.108 0.021 0.062 0.037 0.710 0.084 0.038 0.232

HB 2020 0.153 17.577 0.125 0.026 0.071 0.043 0.714 0.061 0.036 0.171

HB 2021 0.155 17.577 0.120 0.025 0.073 0.042 0.739 0.056 0.035 0.177

HB 2022 0.198 17.806 0.108 0.018 0.085 0.048 0.709 0.038 0.035 0.181

NIB 2018 0.180 17.100 0.127 0.019 0.061 0.034 0.810 0.068 0.036 0.136

NIB 2019 0.142 17.334 0.131 0.021 0.063 0.033 0.820 0.084 0.038 0.154

NIB 2020 0.159 17.564 0.136 0.027 0.067 0.035 0.790 0.061 0.037 0.163

NIB 2021 0.175 17.808 0.129 0.025 0.070 0.039 0.800 0.056 0.037 0.171

NIB 2022 0.301 17.934 0.132 0.023 0.073 0.041 0.810 0.038 0.034 0.171

CBO 2018 0.302 17.213 0.080 0.017 0.063 0.042 0.850 0.068 0.019 0.133

CBO 2019 0.201 17.548 0.079 0.016 0.064 0.045 0.858 0.084 0.021 0.138

CBO 2020 0.152 17.776 0.097 0.026 0.080 0.050 0.856 0.061 0.025 0.151

CBO 2021 0.201 18.214 0.087 0.019 0.074 0.050 0.866 0.056 0.018 0.152

CBO 2022 0.172 18.557 0.099 0.021 0.082 0.052 0.836 0.038 0.019 0.163

LIB 2018 0.259 16.477 0.126 0.027 0.076 0.039 1.062 0.068 0.027 0.134

LIB 2019 0.220 16.831 0.126 0.026 0.079 0.038 1.145 0.084 0.030 0.154

LIB 2020 0.264 17.274 0.110 0.025 0.067 0.034 1.281 0.061 0.026 0.162

LIB 2021 0.150 17.288 0.113 0.010 0.072 0.038 0.818 0.056 0.030 0.183

LIB 2022 0.147 17.311 0.116 0.008 0.062 0.035 0.805 0.038 0.035 0.195

OIB 2018 0.343 16.985 0.109 0.031 0.081 0.040 0.711 0.068 0.025 0.131

OIB 2019 0.228 17.274 0.117 0.023 0.075 0.039 0.706 0.084 0.022 0.107

OIB 2020 0.224 17.337 0.136 0.026 0.077 0.045 0.703 0.061 0.033 0.156

OIB 2021 0.240 17.546 0.131 0.023 0.074 0.047 0.707 0.056 0.026 0.162

71
OIB 2022 0.265 17.768 0.132 0.026 0.079 0.048 0.712 0.038 0.031 0.162

ZB 2018 0.396 16.336 0.136 0.023 0.056 0.026 0.890 0.068 0.033 0.117

ZB 2019 0.217 16.503 0.159 0.040 0.072 0.028 0.950 0.084 0.047 0.168

ZB 2020 0.303 16.733 0.169 0.048 0.084 0.030 0.780 0.061 0.042 0.142

ZB 2021 0.317 17.040 0.178 0.044 0.084 0.031 0.760 0.056 0.042 0.151

ZB 2022 0.299 17.374 0.178 0.049 0.090 0.031 0.770 0.038 0.043 0.162

APPENDX 2
Source SS df MS Number of obs = 50
F(9, 40) = 7.65
Model .122042201 9 .013560245 Prob > F = 0.0000
Residual .07093347 40 .001773337 R-squared = 0.6324
Adj R-squared = 0.5497
Total .192975671 49 .003938279 Root MSE = .04211

liq Coef. Std. Err. t P>|t| [95% Conf. Interval]

bs -.0495665 .0176595 -2.81 0.008 -.0852576 -.0138754

cad -.8850653 .5594674 -1.58 0.122 -2.015791 .2456605
roa 2.789972 1.006202 2.77 0.008 .7563627 4.823582
am .0342033 .0579882 0.59 0.559 -.0829952 .1514018
opef -.4592552 1.077865 -0.43 0.672 -2.637703 1.719192
dg .0205938 .0646476 0.32 0.752 -.110064 .1512515
gdp -2.377937 .4918208 -4.83 0.000 -3.371944 -1.38393
rr 1.348304 1.288964 1.05 0.302 -1.256789 3.953398
nbebills -1.406839 .4055274 -3.47 0.001 -2.22644 -.5872372
_cons 1.449856 .339907 4.27 0.000 .7628779 2.136833

APPENDEX 3
. sum liq bs cad roa am opef dg gdp rr nbebills

Variable Obs Mean Std. Dev. Min Max

liq 50 .20708 .0627557 .132 .396

bs 50 17.5965 .5980634 16.336 19.027
cad 50 .12266 .0214292 .079 .178
roa 50 .02456 .0089401 .003 .049
am 50 .08892 .1094284 .056 .845

opef 50 .04138 .0076795 .026 .062

dg 50 .80964 .1071312 .703 1.281
gdp 50 .0614 .015194 .038 .084
rr 50 .03158 .0083985 .018 .047
nbebills 50 .16194 .0219037 .107 .232

72
APPENDEX 4
. pwcorr liq bs cad roa am opef dg gdp rr nbebills

liq bs cad roa am opef dg

liq 1.0000
bs -0.4306 1.0000
cad 0.3515 -0.4177 1.0000
roa 0.4055 -0.0688 0.6095 1.0000
am 0.0065 0.1881 0.0967 0.1535 1.0000
opef -0.2453 0.3294 -0.4309 -0.5100 -0.0412 1.0000
dg 0.1091 -0.2115 -0.1300 0.0216 -0.0367 -0.2872 1.0000
gdp -0.1346 -0.4764 0.0192 0.0189 -0.0343 -0.2934 0.1898
rr 0.1796 -0.3493 0.7126 0.3394 0.0972 -0.1560 -0.2032
nbebills -0.5013 0.5166 -0.1452 -0.1443 0.0699 0.1818 -0.1184

gdp rr nbebills

gdp 1.0000
rr 0.0077 1.0000
nbebills -0.3907 0.1800 1.0000

APPENDEX 5
. hettest

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance
Variables: fitted values of liq

chi2(1) = 2.83
Prob > chi2 = 0.0925

APPEDEX 6
. estat imtest,white

White's test for Ho: homoskedasticity

against Ha: unrestricted heteroskedasticity

chi2(49) = 50.00
Prob > chi2 = 0.4334

Cameron & Trivedi's decomposition of IM-test

Source chi2 df p

Heteroskedasticity 50.00 49 0.4334

Skewness 17.76 9 0.0380
Kurtosis 0.03 1 0.8671

Total 67.79 59 0.2025

73
APPENDEX 7
. swilk res

Shapiro-Wilk W test for normal data

Variable Obs W V z Prob>z

res 50 0.97891 0.992 -0.017 0.50698

APPENDEX 8
. vif

Variable VIF 1/VIF

cad 3.97 0.251788

rr 3.24 0.308826
bs 3.08 0.324449
roa 2.24 0.447242
nbebills 2.18 0.458691
opef 1.89 0.528199
gdp 1.54 0.648094
dg 1.33 0.754498
am 1.11 0.898786

Mean VIF 2.29

APPENDEX 9
Wooldridge test for autocorrelation in panel data
H0: no first order autocorrelation
F( 1, 9) = 4.827
Prob > F = 0.0556

APPENDEX 10
. sktest res

Skewness/Kurtosis tests for Normality

joint
Variable Obs Pr(Skewness) Pr(Kurtosis) adj chi2(2) Prob>chi2

res 50 0.1295 0.5877 2.74 0.2542

APPENDEX 11
. ovtest

Ramsey RESET test using powers of the fitted values of liq

Ho: model has no omitted variables
F(3, 37) = 2.41
Prob > F = 0.0826

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APPENDEX 12
. ovtest

Ramsey RESET test using powers of the fitted values of liq

Ho: model has no omitted variables
F(3, 38) = 2.26
Prob > F = 0.0968

APPENDEX 13
. hausman fixed random

Coefficients
(b) (B) (b-B) sqrt(diag(V_b-V_B))
fixed random Difference S.E.

bs -.1167131 -.0495665 -.0671466 .0264395

cad -.7338331 -.8850653 .1512322 .407263
roa 1.374792 2.789972 -1.41518 .4879633
am -.0105996 .0342033 -.0448028 .
opef -.7575139 -.4592552 -.2982586 1.032172
dg .1868353 .0205938 .1662415 .0621971
gdp -3.12392 -2.377937 -.7459828 .3145869
rr -3.489488 1.348304 -4.837792 1.848945
nbebills -.0600794 -1.406839 1.346759 .3240777

b = consistent under Ho and Ha; obtained from xtreg

B = inconsistent under Ha, efficient under Ho; obtained from xtreg

Test: Ho: difference in coefficients not systematic

chi2(9) = (b-B)'[(V_b-V_B)^(-1)](b-B)
= 5.65
Prob>chi2 = 0.7742
(V_b-V_B is not positive definite)

APPENDEX 14
. xttest0

Breusch and Pagan Lagrangian multiplier test for random effects

liq[b,t] = Xb + u[b] + e[b,t]

Estimated results:
Var sd = sqrt(Var)

liq .0039383 .0627557

e .0011713 .0342247
u 0 0

Test: Var(u) = 0
chibar2(01) = 0.00
Prob > chibar2 = 1.0000

75