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Liquidity management and its effects on commercial banks profitability

Monday, December 5, 2022

 

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

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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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