Liquidity management and
its effects on commercial bank's profitability
Department: Banking and Finance
No of Pages: 57
Project Code: BFN12
References: Yes
Cost: 5,000XAF Cameroonian
: $15 for International students
CHAPTER ONE
INTRODUCTION
In
every system, there are major components that feature paramount for the
survival ssial banks are selected as the main focus of this study.
Financial
inter-mediation role of the commercial banks hence becomes the bed-rock of the
two major functions of commercial banks namely deposit mobilization and credit
extension. An adequate financial intermediation requires the purposeful
attention of the bank management to profitability and liquidity, which are two
conflicting goals of the commercial banks.
These
goals are parallel in the sense that an attempt for a bank to achieve higher
profitability will certainly erode its liquidity and solvency positions and
vice versa. Practically, profitability and liquidity are effective indicators
of the corporate health and performance of not only the commercial banks
Eljelly (2004), but all profit-oriented ventures.
These
performance indicators are very important to the shareholders and depositors
who are major publics of a bank. As the shareholders are interested in the profitability
level, the depositors are concerned with liquidity position which determines a
bank's ability to respond to the withdrawal needs which are normally on demand
or on a short notice as the case may be.
1.1 Background to the
Study
In every system, there are major components
that feature paramount for the survival of the system. This is also applicable
to the financial systems.
The
banking institutions had contributed significantly to the effectiveness of the
entire financial system as they offer an efficient institutional mechanism
through which resources can be mobilized and directed from less essential uses
to more productive investments.
The
Financial Institutions that fall within the ambit of the 1985 ordinance
relating to the formation of credit establishments and Presidential Decree No
9011496 of November 9, 1990 defining a 'Credit Establishment' were relatively
few, especially when one takes into consideration the size of the banking
sector in the Western World and even some Third World Countries with better
regulated and more competitive banking sectors.
However,
the Republic of Cameroon had one of the highest numbers of institutions that
carried out bank related business in the Central African Sub-Region. The
Country as noted, hosts the headquarters of the Bank of Central African States.
With
the withdrawal in late 1984 of the business licence of the International Bank
of Africa Cameroon (IBAC) and the creation of the Highland Bank
Banks
on request were been authorised by the Ministry of Finance and Economy to open
branches and agencies in different parts of the country.
As
a matter of fact most of those banks have branches and periodic offices all
over the National territory. That same
Ministry of Finance and Economy was the sole competent authority that grants
authorisations.
It
is worth noting that there were a series of credit institutions whose
activities did not really tie in with those of Commercial banks approved by the
state, but which fall under the Presidential Decree of November 1990 defining
Credit Institutions.
The
Banks and the said Credit Institutions did carry out routine banking
transactions and operations to satisfy the needs of their respective clients.
Commercial bank activities like accepting
deposits, allowing customers the use of cheques, granting credit and
overdrafts, foreign exchange transactions and operations, acting as agents for
customers, providing safe custody for valuables, etc. were not peculiar
concepts to the Cameroonian banking system although some of these are not well
developed and the
public not properly
sensitised to the various
services put at their disposal by those institutions.
Recent
trends in western banking had induced some banks in the country to introduce
new products to the Cameroon banking system. Some of these include insurance
and lodging schemes launched in conjunction with Insurance companies.
Automatic
teller machines and a valiant local traveller's cheques the (flash cash)
operated by C.C.E.L banks were some of the innovations to speed up clientele
service and improve customer satisfaction. Most banks had begun to understand
that the development of a dynamic and personalised clientele department was
very essential for their very survival.
The
serious lapses surrounding cheque clearance, whether within the city or up
country, were alarming. It was expected that in the next few months this
situation which is gradually improving would witness very great improvement
with the adoption of modern and sophisticated communication networks by most of
these banks in the country.
1.2 Problem Statement
Liquidity was an instrumental factor during
the recent financial crisis of the 1990. As uncertainty led funding sources to
evaporate, many banks quickly found themselves short on cash to cover their
obligations as they fall due.
In
extreme cases, banks in some countries failed or were been forced into mergers.
As a result, in the interest of broader financial stability, authorities in
many countries, including Cameroon, provided substantial amounts of liquidity.
Cameroon
like any other African Country had a number of regulatory bodies that regulated
the banking system in the country. There is the BEAC (Bank of Central African
States) which clearly defines the monetary policy of the sub-region.
Within
BEAC, there is the Central African Banking Commission or 'Commission Bancaire
de l'Afrique Central' best known by its French acronym COBAC. As seen, COBAC
though considered as an arm of BEAC was an institution vested with
supra-national powers whose decision can abrogate national texts relating to
Banking.
This
commission had a supervisory role over all the banks and financial institutions
of the Central African Sub-Region and sees to it that these banks respect the
texts governing banking at the national as well as the Sub-Regional level.
This
Commission which was created by a convention signed by the six BEAC member
states in October 16, 1990 is also empowered to penalise banks that did not
adhere to applicable texts governing them.
By
virtue of section 13 of the convention, the commission could even withdraw the
business licence of a bank and ask it to cease its activities immediately as
was the case with the International Bank of Africa Cameroon (IBAC) recently and
the First Investment Bank (F.LB.) in May 1993.
Section
29 of the 1985 ordinance stipulates that "Credit Institutions" in
Cameroon were placed under the tutelage of the Ministry of Finance and the
Economy. By virtue of that section, it was clear that the Cameroon Government
through its Ministry of Finance and Economy regulate banking activities in Cameroon.
There
was also the National Credit Council, the national commission for the control
of banks and Financial Institutions and the National Professional Bankers
Associations all bodies created by the presidential Decree of February 8, 1978.
These organisations were placed under the Ministry of Finance and played a
statistical role in the Banking sector of the economy.
The
minimum statutory capital requirement for a commercial bank is fixed at F.CFA 1
billion in accordance with Article 1 of Decree No 9011470 of 9 November 1990.
Article 2 of that same Decree stipulated that proof of the 1billion F.FCA paid
up share capital must be available before depositing a request to obtain an
operating licence.
The
paid up capital would serves as a basis for a number of ratios defined by COBAC
in determining the 'health' of the banks. It was however more prudent to use
the concept of net worth rather than capital per say in evaluating banks.
In
Cameroon, a commercial bank was authorised to lend up to twenty times its net
worth. It might however not lend more than 15% of its net worth to
shareholders, Board members, management and staff put together.
If
an engagement to any particular client is above 15% of the net worth of the
bank, then total lending to all such clients grouped together should not exceed
8 times the net worth of that establishment. The COBAC requirement also stated
that no bank should lend more than 45% of its net worth to any single client.
This
directive though welcomed, placed some limitations on banks with a broad-based
popular capital structure wherein shareholders were discouraged from conducting
their business affairs with a particular bank they invested in.
The
banks had always had their interest rates fixed and adjusted by the National
Monetary Authority, usually in collaboration with the Central Bank (BEAC).
Within the last few years, at that same time as the restructuring of the
Banking system and the implementation of the financial programmes backed by the
I M.F. and the World Bank, there had been an impressive tendency to simplify
the structure and liberalise interest rates.
However,
the Central Bank, by a decision of its board of Directors, was authorised to
revise its interest rate for operations initiated by the Banking system
whenever the monetary situation of that zone so warrants.
Banks
were authorised to freely negotiate deposit interest rates with their clients
while remaining within the guidelines fixed by the monetary authorities. This
at times meant Commercial banks attracted huge sums of money from the public in
the form of deposits.
The
impacts of the 2008/2009 credit crunch are being felt again with a lack of
liquidity in the banking sector and renewed economic uncertainty keeping the
cost of finance high.
In the aftermath of the crisis, there was a
general sense that banks had not fully appreciated the importance of liquidity
risk management and the implications of such risk for the bank itself, as well
as the wider financial system.
As
such, policymakers (COBAC) had suggested that banks should hold more liquid
assets than in the past, to help self‐insure against potential liquidity or
funding difficulties. This had led to an international desire for common
measures and standards for liquidity risk, culminating in ongoing work by the
Basel Committee on Banking Supervision (BCBS 2010).
Base on the credit creation principle, commercial banks ensures that the idle funds borrowed from depositors, were reinvested in different classes of portfolio.
Since
the main objective of commercial banks was to safeguard the idle funds
collected from depositors, there arose problems because there might be a point
where, these commercial banks find it difficult to meet its financial and
contractual obligation, both in the short and in long run.
This
was in situations where depositors seek for their funds. That could cause a
reputation risk due to loss of confidence in banks , hence discredited these
banks.
In
addition, more problems arose as increase competition especially with micro
finance institutions has pooled most customers to these micro finance houses
especially in the 21st century.
Notwithstanding,
many banks have been created since the last decade, which further widens the
competition gap within the banking sector. Due to that, commercial banks should
operate on the motive of profit maximisation, instituting at all level a risk
management department and insuring that there exists enough liquidity to
finance their clients demand for cash.
Assets
and most especially liquid cash was the most valuable and risky asset of
commercial banks. The problem thus arise on what optimum level to identify,
select and maintain assets, so as to strike a balance between the commercial
banks profitability and liquidity for those two objectives were not correlated.
The
problem was wider since, most micro finance institution and some commercial
banks were more profit oriented rather than been liquidity management oriented.
This
research seeks to investigate other problems such as, why many individuals
within this region, prefer lending their funds to micro finance houses with
little credibility, than commercial banks (2011-2012 security finance company
ltd) which have branches all over Africa and the world.
As
well, it looks at the problem of identifying that proportion of liquid cash to
keep as idle balances at a given time. In addition, it would also examine the
problem of banks using their working capital to carry out long term
investments, which could lead to shortage of liquid cash to meet their current
financial obligation.
The
study intends to answer the following questions amongst others, relevant to
the study topic;
- What is liquidity?
- How is liquidity computed?
- What is profitability in banks?
- What is the conflict between liquidity and profitability?
- How many commercial banks do we have in Cameroon?
- Do commercial banks in the Northwest Region; keep the minimum liquidity ratio required by BEAC at all times?
- Do these banks use their working capital to carry out long term investments?
- What is the opportunity cost attached to liquidity?
1.4. Objectives of the
Study
The
competitive environment of the financial institutions was so tense that any
commercial bank that aimed to survive must be fully aware of the consequences
of its liquidity and profitability obligations as both variables could make or
destroy its future. This study was largely centered on the following
objectives;
- To identify the problems of liquidity management.
- To assess the impact of liquidity management to the profitability of commercial banks.
- To make recommendations
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