A Research Proposal on

Impact of liquidity on banks profitability

Submitted By:
Rashmee Maharjan
MBA, 8th batch

Submitted To:
Prof. Dr. Kundan DuttaKoirala
School of Management
Tribhuvan University

In the partial fulfillment of the requirement for the degree of

Master in Business Administration (MBA) 3rd Semester

10thJanuary, 2017
 ACKNOWLEDGEMENT

This reporthas been prepared under Business Research Methodology for the partial fulfilment of
requirements for the course of Masters of Business Administration (MBA) under the Faculty of
Management of Tribhuvan University.

I would like to thank Prof. Dr. Kundan Dutta Koirala for providing us with an opportunity to
prepare a research proposal and for his valuable direction, kind guidance and continuous
cooperation throughout the semester.

I also wish to thank my friends for their moral support, valuable guidance and suggestions in
preparing this report.

Rashmee Maharjan
Roll No. 17
MBA 8th Batch
1.1 Background of the study

Banks perform the two major functions of collecting surplus funds from the general public i.e.
deposits and lending them to the ones who need funds i.e. lending. This function performed by
banks is known as financial-intermediation role. The banks performance during a given period
is depicted by liquidity of the bank and its profitability.
The liquidity in the commercial bank represents the ability to fund its obligations by the
contractor at the time of maturity, which includes lending and investment commitments,
withdrawals, deposits, and accrued liabilities (Amengor, 2010). A bank should make sure that it
does not suffer from excess liquidity or lack of liquidity to meet its day to day operation and
unexpected occurrences.Banks are often evaluated on their liquidity, or their ability to meet cash
and collateral obligations without incurring substantial losses. In either case, liquidity
management describes the effort of investors or managers to reduce liquidity risk exposure.
(Investopedia)
Bank profitability is the ability of a bank to generate revenue in excess of cost, in relation to the
banks capital base. A sound and profitable banking sector is better able to withstand negative
shocks and contribute to the stability of the financial system. (Athanasoglou, Brissimis and Delis,
2005). A banks profitability is affected by numerous factors which may be due to internal as well
as external factors. Some of them are expense management, loan composition, composition of
bank deposits, market interest rates, banks earning capacity, operating efficiency, changes in
capital and liquidity management, financial regulation, competition in the market, market share,
market growth.
Excess liquidity or lack of liquidity has adverse effect the performance of a bank. So, liquidity
management remains the main focus of all the banks. Most of the past researches suggest that
liquidity is one of the factor determining a banks profitability. But some studies have shown that
theres non-linear relationship between banks profitability and liquidity.
This study will focus on examining the impact of liquidity and liquidity indicators on the
profitability of Nepalese listed banks.
1.2 Research Problem Statement

The banks of a country represent the soundness of an economy and the performance of a bank is
depicted by its profitability. Past researches have considered liquidity to be a major determinant
of a banks profitability though it is influenced by numerous factors. But some other research
results are contrary i.e. show non-linear relationship between liquidity and banks profitability.
In context of Nepal, we are yet to examine the relationship between the liquidity and banks
profitability in the recent years.

Research questions
The study aims at answering the following questions:
What nature of the relationship exists between liquidity of bank and banks profitability?
Does liquidity management affect the banks profitability?
What effect do liquidity indicators have on the banks profitability?

1.3 Objectives of the study

This study focuses on examining the impact of liquidity of a bank on its profitability as liquidity
is considered to be a major factor determining the banks profitability among all other factors.
This research will emphasize on identifying the important indicators of the liquidity
management, the effect of each indicator on the banks' profitability, identify the effect of the
liquidity management on profitability of the listed commercial banks.

1.4 Literature Review

1.4.1 Concept of banks liquidity

The liquidity in the commercial bank represents the ability to fund its obligations by the
contractor at the time of maturity, which includes lending and investment commitments,
withdrawals, deposits, and accrued liabilities (Amengor, 2010). Liquidity is considered to be a
key determinant impacting the banks profitability. Banks are responsible for managing liquidity
creation and liquidity risk. Liquidity creation helps depositors and companies stay liquid, for
companies
especially when other forms of financing become difficult. Managing liquidity risk is to ensure
the banks own liquidity so that the bank can continue to serve its function (Vossenand& Ness,
2010).The main measures of liquidity current ratio, capital ratio, cash ratio, quick ratio,
investment ratio.

Theories of liquidity management:

a. The Real Bills Doctrine

The real bills doctrine or the commercial loan theory states that a commercial bank should
advance only short-term self-liquidating productive loans to business firms. Self-liquidating
loans are those which are meant to finance the production, and movement of goods through the
successive stages of production, storage, transportation, and distribution.

b. The Shift-Ability Theory:

The shift-ability theory of bank liquidity was propounded by H.G. Moulton who asserted that if
the commercial banks maintain a substantial amount of assets that can be shifted on to the other
banks for cash without material loss in case of necessity, then there is no need to rely on
maturities. According to this view, an asset to be perfectly shift able must be immediately
transferable without capital loss when the need for liquidity arises.

c. The Anticipated Income Theory:

The anticipated income theory was developed by H.V. Prochanow in 1944 on the basis of the
practice of extending term loans by the US commercial banks. According to this theory,
regardless of the nature and character of a borrowers business, the bank plans the liquidation of
the term-loan from the anticipated income of the borrower. A term-loan is for a period exceeding
one year and extending to less than five years.

d. The Liabilities Management Theory:

This theory was developed in the 1960s. According to this theory, there is no need for banks to
grant self- liquidating loans and keep liquid assets because they can borrow reserve money in the
money market in case of need.(microeconomics.com)
1.4.2 Concept of bank profitability

Bank profitability is the ability of a bank to generate revenue in excess of cost, in relation to the
banks capital base. A sound and profitable banking sector is better able to withstand negative
shocks and contribute to the stability of the financial system. (Athanasoglou, Brissimis and Delis,
2005). Bank profitability is the indicator of the health and performance of any bank. Corporate
profitability may be improved through ratio analysis, breakeven analysis, marginal analysis, cost
control or through financial control. (Ibe, 2013)

1.4.3 Empirical review

Many researchers have studied the impact of liquidity on banks profitability in different
countries and under different situations. The results of those past researches are as follows:
Ibe (2013) examined the impact of liquidity management on the profitability of banks in Nigeria.
The findings of the study showed that liquidity management is indeed a crucial problem in the
Nigerian banking industry and that banksneed to determine its optimal liquidity position to
resolve the liquidity/profitability trade-off.
Lartey et al. (2013) sought to find out the relationship between the liquidity and the profitability
of banks listed on the Ghana Stock Exchange. It was found that for the period 2005-2010, both
the liquidity and the profitability of the listed banks were declining. Again, it was also found that
there was a very weak positive relationship between the liquidity and the profitability of the
listed banks in Ghana.
Alshatti (2015) investigated the effect of the liquidity management on profitability in the
Jordanian commercial banks.The researcher recommended that there is a need for an optimum
utilization of the available liquidity in a various aspects of investment in order to increase the
banks' profitability, and banks should adopt a general framework of liquidity management to
assure sufficient liquidity for executing their operations more efficiently, and they should initiate
an analytical study of the evolution rates of liquidity and their ability to achieve a balance
between sources and uses of funds.
Pradhan and Shrestha (n. d) examined the impact of liquidity on bank profitability in nepalese
commercial banks. The study concluded that liquidity status of the bank plays important role in
banking performance in case of Nepalese commercial banks. This study revealed that investment
ratio, liquidity ratio and capital ratio has positive impact on bank performance, while quick ratio
has positive impact on the same.

1.5 Theoretical Framework

This study involves the following variables:

a. Dependent variables
The dependent variable for this study is banks profitability.
b. Independent variables
The factors that affect the banks profitability are independent variables. The independent
variable for this study is liquidity of the bank.

Dependent Variable Independent Variable

Liquidity Bank's Profitability

Fig. Theoretical Framework

1.6 Hypothesis

The main objective lies in identifying the relationship between the liquidity and banks
profitability. So, the interest of the study is to examine how changes in liquidity affects the
profitability of the bank. We have set following hypotheses based on the review of past articles
and research papers.
Hypothesis 1:There is no significant relationship between liquidity and profitability of the listed
banks.
Hypothesis 2: The liquidity indicators have no significant effect on banks' profitability.
Hypothesis 3:The liquidity management has no positive impact on banks profitability.
1.7 Research Methodology

In this chapter the methodology to be used for conducting the research is presented. This chapter
consists of research design, method of data collection, sources data, qualitative and quantitative
methods etc.

a. Research Design
It is a descriptive research thatattempts to explore and explain while providing additional
information about the research topic. This study attempts to examine the impact of liquidity on
the banks profitability for which secondary sources of data will be used. Further quantitative
data analysis tools will be used to analyze the data collected.

b. Population and sample

The banking industry of Nepal consists of 30 commercial banks, 73 development banks, 48
finance companies, 41 micro finance financial institutions but only 4-5 commercial banks data
will be gathered for the research purpose judgmental sampling techniques.

c. Sources of Data
The data that we require to analyze the impact of liquidity on banks profitability are already
gathered and published by the respective banks. So, the data will be collected through the
secondary sources.

d. Data collection Techniques

The secondary sources of the data will be annual financial statements published by the banks to
study the liquidity and profitability ratios of the respective banks. The advantage of using the
secondary data is that it is easily available and hence consumes less time to gather the relevant
information.

e. Data Analysis Tools

Financial ratios like profitability ratios and liquidity ratios will be computed to study the impact
of liquidity on the banks profitability. Other quantitative data analysis like time series analysis,
and regression and correlation analyses will be performed using SPSS software and MS-Excel.
The diagrams and graphs will also be used for better presentation.

1.8 Limitations of the study

This research will be subject to the following limitations:
The study will be based only on secondary data collected.
The conclusion drawn from this study may not be generalizable to all banks as it is
basedonly on few listed banks analysis.

1.10 Organization of the Study

Chapter 1: Introduction
The first chapter will consist of a brief description of background of banks and the liquidity
affecting any banks profitability.

Chapter 2: Literature Review

This chapter will consist of review of past articles and research papers on liquidity and banks
profitability published nationally and internationally.

Chapter 3: Research Methodology

This chapter will consist of the methods and strategies that will be used for the purpose of the
study.
Chapter 4: Analysis and Findings
This chapter will consist of the analysis and findings of the study that will be conducted.

Chapter 5: Conclusion and Recommendation

This chapter will consist of the conclusion of the analysis and findings of the study and
recommendations for future improvement based on the study will be provided.
1.10 Study Timeline

Particulars Week 1 Week 2 Week 3 Week 4 Week 5 Week 6 Week 7 Week 8

Literature Review

Data collection

Data analysis

Report writing

Report Submission
References
Alshatti, A. S., (2015). The Effect of the Liquidity Management on Profitability in the Jordanian
Commercial Banks.International Journal of Business and Management, 10(1)

Amengor, E. C. (2010). Importance of Liquidity and Capital Adequacy to Commercial Banks. A

Paper Presented at Induction Ceremony of ACCE, UCC Campus.

Athanasoglou, P. P., S. N. Brissimis and M. D. Delis, (2005) Bank-Specific, Industry- Specific

and Macroeconomic Determinants of Bank Profitability.

Ibe, S. O. (2013). The Impact of Liquidity Management on the Profitability of Banks in Nigeria.
Journal of Finance and Bank Management, 1(1), 37-48

http://www.microeconomicsnotes.com/banking/commercial-banks/top-4-theories-of-liquidity-
management/1234

Lartey, V., Antwi, S., &Boadi, E. (2013). The Relationship between Liquidity and Profitability
of
Listed Banks in Ghana. International Journal of Business and Social Science, 4(3), 48
56.

Pradhan, R. S., Shrestha, D. (n. d). Impact of liquidity on bank profitability in Nepalese
commercial
banks

Vossenand, D. (2010). Theoretical framework of profitability as applied to commercial banks in

Malaysia. European Journal of Economics, Finance and Administrative Sciences, 19(9),
75- 97.