COMMERCIAL BANKS AS A MEANS TO MEASURES LIQUIDITY IN THE NIGERIAN FINANCIAL SYSTEM 1980-2010
CHAPTER ONE
INTRODUCTION
1.1    BACKGROUND TO THE STUDY
    Financial institutions have contributed 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. In the performance of this financial inter-mediation role, the financial institutions have proved to be effective conduits between savers and borrowers. Among the financial institutions that make themselves available for this all-important role are savings banks, development banks and commercial banks. Commercial banks have overtime become very important institutions in the financial system as they function as retail banking units facilitating the transfer of financial assets that are less desirable from some part of the public (Fund Lenders) into other financial assets which are more widely preferred by greater part of the public (Fund Seekers). In view of this role and of the fact that the activities of the commercial banks affect the greater part of the society, commercial banks are selected as the main focus of this study.
    Financial intermediation role of the commercial banks becomes the bed-rock of the two major functions of commercial banks namely deposit mobilization and credit extension. An adequate financial inter-mediation 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, 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. Sizer (1977) opined that “profitability is the primary aim and the best measure of efficiency in competitive business”. It is important to mention at this point that the profitability of a bank is greatly determined by the interest rate spread or the difference between the money borrowed at lower interest rate from savers and the money lent to users at higher rate. Ordinarily, one should expect a high profit from a bank with high loans and advances. But experiences have shown that high level of loans and advances easily culminate into bank liquidity, distress and bankruptcy-situations where a bank is not able temporarily or permanently to meet up with the withdrawal needs of the depositors. Such situations erode the confidence of the depositors in the banking sector and consequently lead to deposit flight and loss of profitability. In the opinion of Van-Horne (1986) “The firm can reduce the profitability of bankruptcy by maintaining liquidity”. According to him, “As liquidity is increased, the profitability of technical insolvency can be reduced”. With profitability objective conflicting with liquidity objective of a bank, and with the interest of the shareholders conflicting with the interest of the depositors, there is the need to reconcile and harmonize these conflicting positions through effective liquidity management.
Money markets play a key role in banks ’liquidity management and the transmission of monetary policy. In normal times, money markets are among the most liquid in the financial sector.  By providing the appropriate instruments and partners for liquidity trading, the money market allows the refinancing of short and medium-term positions and facilitates the mitigation of your business’ liquidity risk. A developed, active and efficient interbank market enhance the efficiency of central bank’s monetary policy, transmitting its impulses into the economy best. Thus, the development of the money market smoothies the progress of financial intermediation and boosts lending to economy, hence improving the country’s economic and social welfare.
Iyiegbuniwe (2005) opines that although the Nigerian money market has experience significant growth, both in the  breadth of securities as well as the volume of trading since the liberalization of the financial system in 1986,it still needs to be deepened further to achieve the required vibrancy that is expected of a money market. This is not to say that the Nigerian money market is ineffective, therefore there is the need to examine some aspects of this market by evaluating banks’ management of liquidity in the Nigerian money market.
 1.2    STATEMENT OF THE PROBLEM
    Through the financial intermediation role, the commercial banks make use of the idle funds mobilized from the depositors by investing such funds in different classes of portfolios. Such business activity of the bank is not without problems since the deposits from these fund savers which have been invested by the banks for profit maximization can be recalled or demanded when the later is not in position to meet their financial obligations. Considering the public loss of confidence as a result of bank distress which has bedeviled the financial sector in the last decade, every commercial bank should ensure that it operates on profit and at the same time meets the financial demands of its depositors by maintaining adequate liquidity. Therefore the research questions are:
Is there a significant relationship between liquidity and profitability of commercial banks?
Which money market instrument significantly impact on commercial banks profitability?
What is the relationship between the liquidity and deposit level and commercial banks profitability in Nigeria?
1.3    OBJECTIVES OF THE STUDY
    The objectives of the study are to:
Determine the relationship between liquidity and profitability of commercial banks in Nigeria.
Identify money market instruments that have significant impact on commercial bank profitability.
Determine the relationship between liquidity level and deposit level of commercial banks.
1.4    HYPOTHESES
    Arising from the statement of research problems and objectives of the study, the following hypotheses stated in the null form were tested:
(i)    There is no significant relationship between liquidity and profitability of commercial banks profitability in Nigeria.
(ii)    There is no significant relationship between liquidity level and deposit level of commercial banks profitability in Nigeria.
(iii)    There is no significant relationship between Treasury bills assets and deposit level of commercial banks profitability in Nigeria.
1.5    THE SIGNIFICANCE OF THE STUDY
    In view of the fact that commercial banks operate on two motives which are: liquidity and profitability in their bid to satisfy their two major publics the depositors and shareholders, it becomes necessary for the banks to harmonize these two motives with the aim of satisfying these two publics simultaneously. Consequently, the commercial banks need effective and efficient liquidity management approaches and principles which will help them to realize the desired levels of each of the motives. Thus, it is hoped that the results obtained from this study will be relevance to the monetary authority, the banks and the bank customers, bank shareholders and also to the general public and national economy. They will also help the government in setting realizable and appropriate liquidity and cash ratios that will not be inimical to the operations and survival of the commercial bank.
1.6    SCOPE OF THE STUDY
    The study will be restricted to Six (6) Money Market instruments held by commercial banks which are measures of Liquidity in the Nigerian financial system, and will cover a time period of thirty (31) years ranging from 1980 – 2010
1.7    LIMITATION OF THE STUDY
    Generally, no study is without limitation and this study of course is not an exemption. The only limitations in this study are the accuracy of data from its source and the measurement and estimation procedure employed in the analysis. However, effort was made to ensure that errors are minimized so that the results obtained are valid and reliable with respect to the data used.