ABSTRACT
This study examined cash and credit management and commercial banks’ liquidity in Nigeria.
The major aims of the study were to find empirical evidence of the degree to which effective cash
and credit management affects the liquidity performance in commercial banks and how
commercial banks can prevent illiquidity by engaging in these practices. Considering the nature
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of the survey, quantitative methods of research were applied. In attempt to achieve the objectives
of the study, several findings were made through the analysis of the financial statement of
various commercial banks used as samples over a period of seven years. The data obtained from
Secondary sources were analyzed through with the use of panel data regression and correlation
co-efficient. A few hypothesis were formulated and were statistically tested through panel
regression model. Findings from the testing of this hypothesis indicate that there is significant
relationship between cash and credit management and illiquidity. That means liquidity in
commercial banks is significantly influenced by credit and cash management. The study
concluded that for the success of operations and survival, commercial banks should not
compromise efficient and effective cash and credit management and that both illiquidity and
excess liquidity are “financial diseases”. Also, that cash and credit management are high
important in order to avoid insolvency or illiquidity. Finally the study recommends that banks
should not neglect their responsibility of cash management and focus mainly on credit
management.
TABLE OF CONTENT
Page
TITLE PAGE……………………………………………………………………………………. I
CERTIFICATION………………………………………………………………………………II
vii
DECLARATION …………………………………………………….……………………….. III
DEDICATION ………………………………………………………………………………… IV
ACKNOWLEDGEMENT………………………………………………………………………V
ABSTRACT…………………………………………………………………………………….VI
TABLE OF CONTENTS………………………………………………………………………VII
LIST OF FIGURES…..…………………………………………………………………………XI
CHAPTER ONE: INTRODUCTION…………………………………………………………..1
1.1 Background information………………………………………………………………………1
1.2 Statement of the problem………………………………………………………………………3
1.3 Objectives of the study………………………………………………………………………..4
1.4 Research questions……………………………………………………………………………4
1.5 Research hypothesis……………………………………………………………………………5
1.6 Significance of the study………………………………………………………………………5
1.7 Scope of the study……………………………………………………………………………..6
1.8 Limitation of the study………………………………………………………………………..6
1.9 Organization of the study……………………………………………………………………..7
1.10Definition of terms……………………………………………………………………………7
CHAPTER TWO: LITERATURE REVIEW………………………………………………..10
2.1 Introduction…………………………….……………………………………………………10
2.2 Conceptual clarification……………………………………………………………………..10
2.2.1 Credit Risk…………………………………………………………………………….10
2.2.2 Types of credit risk……………………………………………………………………11
2.2.3 Credit events…………………………………………………………………………..13
2.2.4 Assessing Credit Risk…………………………………………………………………14
2.2.5 Analytical Template for Credit Risk Assessment…………………………………..…17
2.2.6 The concept of Performing and Non-performing loans……………………………….18
2.2.7 Credit Risk Management or Credit Management………………………………………20
2.2.8 Credit Risk Management Strategies……………………………………………………21
2.2.9 Reasons for Holding Cash…………………………………………………………..…24
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2.2.10 Target Cash Balance………………………………………………………………….25
2.2.11 Cash Management…………………………………………………………………….25
2.2.12 General Principles of Cash Management……………………………………………..27
2.2.13 Functions of Cash Management………………………………………………………30
2.2.14 Elements or Components of Cash Management………………………………………32
2.2.14.1 Cash Pooling Techniques……………………………………………………32
2.2.15 Cash flow Forecast and Cash flow Statement…………………………………………34
2.2.15.1 Cash flow forecast………………………………………………………….34
2.2.15.2 Cash flow statement…………………………………………………………35
2.2.16 Illiquidity/Liquidity……………………………………………………………….….36
2.2.17 Elements of Liquidity…………………………………………………………….…..38
2.2.18 Liquidity Risk and Liquidity Creation in Commercial Banks…………………….….40
2.2.19 Liquidity Management………………………………………………………………..42
2.2.20 Cash and Credit Management and Liquidity Performance in Commercial Bank……43
2.3 Empirical Review of Literatures…………….………………………………….……………47
2.4 Theoretical Framework…………..…………………………………………………………..56
2.4.1 Loan Pricing Theory……………………………….…………………………………..56
2.4.2 Theory of Multiple Lending……………………………………………………………57
2.4.3 Hold-up and Soft-Budget-Constaint Theories…………………………………………57
2.4.4 The Signalling Arguments……………………………………………………………..58
2.4.5 Credit Market Theory………………………………………………………………….58
2.4.6 The Baumol Theory……………………………………………………………………58
2.4.6.1 Assumptions……………………………………………………………………59
2.4.6.2 Limitations……………………………………………………………………..60
2.4.6.3 Use of Baumol Theory…………………………………………………………60
2.4.7 The Miller Orr Model………………………………………………………………….60
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2.4.8 The Line of Credit Model……………………………………………………………..62
CHAPTER THREE: METHODOLOGY…………………………………………………….73
3.0 Introduction……………………………………………………………………………….….73
3.1 Restatement of the Research Hypothesis…………………………………………………….73
3.2 Research Design………………………………………………………………………………73
3.3 Research Population………………………………………………………………………….74
3.4 Sample and Sampling Technique…………………………………………………………….74
3.5 Research Instruments…………………………………………………………………………75
3.6 Validity and Reliability of Instrument……………………………………………………….75
3.7 Method of Data Collection……………………………………………………………………75
3.8 Data Validation………………………………………………………………………………75
3.9 Data Presentation and Analysis Techniques…………………………………………………76
3.9.1 Multiple Regression Model……………………………………………………………76
3.9.2 Trend Analysis…………………………………………………………………………77
3.9.2.1 Credit Risk Trend………………………………………………………………77
3.9.2.2 Liquidity Performance Trend…………………………………………………..78
CHAPTER FOUR: PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA.
4.0: Introduction…………………………………………………………………………………..79
4.1 Analysis of Results on Panel Data Regression……………………………………….………79
4.2 Graphs Showing the Liquidity Performance in relation to its Credit Risk over Seven years..81
4.3 Analysis and Interpretation of Credit and Liquidity Performance Trend…………………….88
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS…………90
5.1 Introduction…………………………………………………………………………………..90
5.2 Summary of Major Findings…………………………………………………………………90
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5.3 Discussion of Findings……………………………………………………………………….91
5.4 Conclusion……………………………………………………………………………………92
5.5 Recommendations……………………………………………………………………………93
5.6 Contributions to knowledge………………………………………………………….………94
5.7 Areas for Further Studies…………………………………………………………….………94
BIBLOGRAPHY……………………………………………………………………………….95
APPENDIX………………………………………………………………………………….…102
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LIST OF FIGURES
Figure 2.1: The Credit decision as a decision problem
Figure 2.2: Elements or Components of Cash Management
Figure 2.3: Cash flow Cycle
Figure 4.1: Summary of Data used in the Analysis and Interpretation of Credit Risk and
Liquidity Trend.
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CHAPTER ONE
INTRODUCTION
1.1 Background Information
A bank is a financial intermediary and money creator that creates money by lending money to a
borrower, thereby creating a corresponding deposit on the bank‟s statement of financial position.
Commercial Banks are profit-making organizations acting as intermediaries between borrowers
and lenders attracting temporarily available resources from business and individual customers as
well as granting loans for those in need of financial support (Drigă, 2012). Commercial banks
can also refer to banks or a division of a bank that mostly deals with deposits and loans from
corporations or large businesses.
The health of a financial system plays a very important role in the economic development of the
country and it failure can have very tragic consequences for such an economy. In developing
countries like Nigeria, commercial banks through their functions and activities aid the growth
and development of the economy and therefore, are very important to the efficiency and success
of the financial system.
Traditionally, it is the belief of every business that profit is a key indicator of success. This is
very much true but most business have failed to understand that there is more to profitability than
the large figure of retained earnings or reserves in the statement of financial position.
Commercial banks accept deposits from its customers and in turn, generate revenue by lending to
individuals and corporate organizations. The statement of financial position of a commercial
bank is constituent mostly of loans and advances and bonds as the majority of its asset and
deposits as it major liability. This implies that loans make up the bulk of the bank‟s asset and this
make it safe to say the life blood of a commercial bank is credit. As a result of lending, credit
risk is introduced into the activities of the commercial bank and this is the most critical of all risk
faced by the banking institution. If the bank makes bad loans to firms or consumers for example,
the bank will be in a crisis if those loans are not repaid (Mavhiki et al., 2012).
As a matter of fact a bank cannot remain in business if it neglects the credit function (Osayeme
2000). Credit risk is of major concern to commercial banks; therefore, commercial banks need to
put in place risk management measures to help avoid the risk from blooming into something
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greater than they are able to handle which ultimately is illiquidity. Risk management is the
human activity which integrates recognition of risk, risk assessment, developing strategies to
manage it, and mitigation of risk using managerial resources, but credit risk is the risk of loss due
to debtor‟s non–payment of a loan or other line of credit (either the principal or interest or both)
(Campbell, 2007). There is need for commercial banks to adopt appropriate credit appraisal
techniques to minimize the possibility of loan defaults since defaults on loan repayments leads to
adverse effects such as the depositors losing their money, loss of confidence in the banking
system, and financial instability (kithinji, 2010). Hence, credit management is made necessary
for both profitability and liquidity.
Another aspect fundamental to the survival of a commercial bank is its working capital. The
major concern of working capital is cash. Though, cash holds the smallest unit of the total
current asset, like the blood stream of the human body, it gives strength and vitality to the
business enterprise. Cash is king and this hold true irrespective of the business size. The
availability of cash balances is a key determinant of a bank‟s competitive ability because it
provides the means to invest in people, technology and assets.
Cash is both the beginning and end of working capital cycle which keeps the business going.
Hence, every enterprise has to hold necessary cash for its existence. Moreover, steady and
healthy circulation of cash throughout the entire business operations is the basis of business
solvency. Now-a-days, non-availability and high cost of money have created a serious problem
for industry. Nevertheless, cash like any other asset of a company is treated as a tool of profit.
Further, the emphasis is on the right amount of cash, at the right time, at the right place and at the
right cost. In the words of R.R. Bari, “Maintenance of surplus cash by a company unless there
are special reasons for doing so, is regarded as a bad sigh of cash management as the holding of
cash balance has an implicit cost in the form of its opportunity cost.
Cash may be interpreted under two concepts. In narrow sense, “Cash is a very important business
asset, but although coin and paper currency can be inspected and handled, the major part of the
cash of most businesses is in the form of bank checking accounts, which represent claims to
money rather than tangible property.” While in broader sense, “Cash consists of legal tender,
cheques, bank drafts, money orders and demand deposits in banks. Thus, we may conclude that
in narrow sense cash means cash in hand and at bank but in wider sense, it is the deposit in
banks, currency, cheques, bank draft etc. In addition to cash in hand and at bank, “Cash
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management includes management of marketable securities also, because in modern terminology
money comprises marketable securities and actual cash in hand or in bank.” Cash management
in a commercial bank is therefore indispensable.
1.2 Statement of the problem
One of the major and most crucial problems faced by commercial banks now-a-days is
liquidation even after these commercial banks have recorded a high level of profit. It is very
disturbing that a commercial bank that seems fine suddenly winds-up and this always leaves the
customers wondering “How” and “Why.”
Researches carried out over the course of the past few years on the very devastating financial
crisis that rocked the banking industry as a whole in 2008-09 have all shown that most
commercial banks ran out of cash as bad debts, lack of short-term financing and poor profitable
opportunities combined to cause the most severe crisis in the financial sector for decades. But
then the question is; how do banks that are already profitable run out of cash? Or how do banks
that are already in business not put in place all possible measures to ensure continuous
profitability and liquidity?
As a result of these, the major problem identified by this research work as the reason for the
failure of these commercial banks is poor management of their finance (cash and credit). In light
of the above, the problems identified by this research work are summarized as follows:
1. The level of exposure to and the impact of credit risk by commercial banks are not met by
proper strategies and tactics that will help manage this risk effectively for control purposes.
2. Every time a commercial bank performs it lending function, it introduces credit risk into the
business. The exposure to this risk is inversely related to the liquidity position of these banks
but they have failed to see how each credit risk they are exposed to has affected their
liquidity performance over the years.
3. In order to avoid the high cost associated with holding cash whose opportunity cost is the
cost of lost interest, commercial banks keep cash balances which are below the target cash
balance.
4. Banks add the amount of cash required to satisfy its transaction needs to that needed satisfy
its compensatory balances to produce a target cash balance. This result to surplus cash which
if left idle will cause the firm to lose the profit it would have earned if it had been invested.
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1.3 Objectives of the study
In the light of problems that have been identified as the major factors that are responsible for the
failure of commercial banks in Nigeria, this research work would be used to examine the
challenges so as to achieve some specific objectives. The general objective of this study is
establishing a relationship between cash and credit risk management and the liquidity of
commercial banks. The more specific objectives are:
1. To examine the impact of non-performing loans on the liquidity position of commercial
banks.
2. To carefully investigate the influence of effective credit risk management put in place by
these banks on their liquidity performance.
3. To show the credit risk exposure and liquidity performance trends of Nigerian commercial
banks over a given period of time.
4. To develop, explore and evaluate ways in which commercial banks can achieve their target
cash balances to meet their various needs so as to avoid insolvency and aid profitability.
1.4 Research questions
With a view of achieving the specific objectives stated above, the answers to the following
questions are required:
1. To what extent does non-performing loans affect the liquidity position of commercial banks?
2. What influence does effective credit risk management have on the liquidity performance of
commercial banks?
3. What relationship exists between the trend of credit risk and the trend of liquidity
performance of commercial banks over time?
4. Why do commercial banks have to achieve their target cash balances in order to avoid
insolvency?
1.5 Research hypothesis
From the subsequently stated research objectives and questions, the following assumptions have
been made stated both in their null and alternate form as regard the already identified problems
of this study and are going to be tested during the course of this study:
5
Hypothesis 1:
H0: There is no positive and significant relationship between effective credit risk management
and the achievement of target cash balances and the insolvency or liquidity performance of
commercial banks.
H1: There is a positive and significant relationship between effective credit risk management and
the achievement of target cash balances and the insolvency or liquidity performance of
commercial banks.
Hypothesis 2:
H0: Liquidity performance is not affected by increases in credit risk levels in Nigerian
commercial banks.
H1: Liquidity performance tends to decrease with the increase in credit risk levels in Nigerian
commercial banks.
1.6 Significance of the study
Conducting this study would enable the researchers expand their horizon of knowledge on the
importance of cash and credit risk management for commercial banks to enable them make profit
and secure liquidity.
This study will enable Commercial banks see reasons to adopt and implement effectively and
efficient risk management policies in order to tackle the different types of risk that arise in the
course of carrying out their functions.
This study will also enable statutory and regulatory authorities formulate laws and set-up
guidelines that will aid commercial banks and other banking institutions in managing all assets
and liabilities towards the achievement of profit and maintaining a high liquidity position.
This study is carried out also with a view of enhancing the understandability and comprehensive
ability of students, teachers and lecturers on the concepts; cash management, credit management
and liquidity.
Further studies can also be carried out by other scholars on this research work so as to further the
advancement of the quest for knowledge.
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1.7 Scope of the study
This study will be carried on a certain number of firms who have met certain conditions which
includes listing on the Nigerian stock exchange and the availability of consistent and regular
financial statements among others. This research would be carried out in Nigeria. This study is
limited to banks only; commercial banks to be specific. In order to attain a sample population
that is neither too large nor too small, five commercial banks have been selected and a time
frame of seven years has also been employed for the purpose of this study. This time period will
run from the year 2006 to the year 2012. The analysis will be carried out of the audited financial
statements of the selected commercial banks.
1.8 Limitation of the study
In the course of this study, certain challenges were encountered and this imposed a constraint on
the gathering of information or data needed to proffer a dependable solution to the problems
stated in the above section of this study:
1. Time frame: the period of time assigned to the execution of this project was very little as
compared to the amount or bulkiness of the data needed for this study. This limited the
ability to obtain enough information as deadlines needed to be met.
2. Accessibility to information; obtaining the data used for this research work did not come easy
as most of the bankers were not willing to corporate or were hoarding information relatively
important to the conclusions of the study.
3. Also, obtaining permission to leave the premises of the school for the purpose of this
research was made difficult as several strains were placed on the means of obtaining an exeat
from the school authorities.
4. The cost of carrying out this research was unavoidably high. Costs of obtaining materials,
cost of transportation and other cost; necessary and unavoidable in order to ensure the
success of this project were very expensive especially when viewed from the perspective of a
student.
5. This study caused the researcher to joggle the carrying out of this research study with other
school activities, academic and extra-curricular which placed a strain on the time available to
carry out other activities and left very little time for sleep.
1.9 Organization of the study
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This study for the purpose of this research work is structured into five chapters. The first chapter,
also referred to as chapter one was used to introduce the research work in which was contained;
the background information, statement of the problem, the objectives of this study, research
questions, research hypothesis, significance of the study, scope of the study, limitations,
organization and the definition of several terms used in study. The second chapter (chapter two)
shall be used to review various literatures while clarifying certain concepts, theoretical
framework and doing an analytical review. The methodology adopted in the course of this
research shall be discussed in chapter three after which the analysis of the data obtained will be
done in chapter four. Finally, the summary, conclusions and recommendations as regards the
findings will be represented in chapter five.
1.10Definition of Terms
1. Financial system: this is the interplay of financial companies, regulators and institutions
operating on a supranational level. The financial system is possibly the most important
institutional and financial vehicle for economic transformation. A financial system objective is to
supply funds to various sectors and activities of the economy in ways that promote the fullest
possible utilization of resources without the destabilizing consequence of price level changes or
unnecessary interference with individual desires.
2. Economic development: this refers to progress in an economy or the qualitative measure of
this. Economic development usually refers to the adoption of new technologies, transition from
agriculture-based to industry-based economy, and general improvement in living standards of
people.
3. Credit: it is the trust which allows one party to provide money or resources to another party
where that second party does not reimburse the first immediately (thereby generating a debt), but
instead arranges either to repay or return those resources( or other materials of equal value) at a
later date.
4. Credit risk: It is the possibility of losing the outstanding loan partially or totally, due to credit
events (default risk), failure to pay a due obligation, repudiation/moratorium or credit rating
change and restructure. Credit risk arises from the potential that an obligor is either unwilling to
perform on an obligation or its ability to perform such obligation is impaired resulting in
economic loss to the bank.
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5. Retained earnings and reserves: retained earnings are the percentage of the business profits not
distributed to shareholders, to corporate investors or to vendors as part of continuing financial
obligations.
6. Working capital: It is a financial metric which represents operating liquidity available to a
business, organization or other entities including governmental entities. It also refers to the net
liquid assets computed by deducting current liabilities from current assets. It is the cash available
for day-to-day operations of an organization.
6. Profit: It is an income distributed to the owner(s) of a business in a profitable market
production process. Profit can also be referred to as the surplus remaining after total costs are
deducted from total revenue, and the basis on which tax is computed and dividend is paid. It is a
measure of profitability which is the owner‟s major interest in income formation process of
market production. It is the best known measure of success in an enterprise.
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REFERENCES
Audrey Besson-Levine and Richard Young (2011). Improving cash flow using credit
management(2nd edition): Chartered Institute of Management Accountants.
Eric Y.W. Leung: Cash Management. CUHK Business School, The Chinese University of Hong
Kong. PBE Paper II – Management Accounting and Finance.
Idowu Abiola (2014)The Impact Of Credit Risk Management On The Commercial Banks
Performance In Nigeria; International Journal of Management and Sustainability, 2014, 3(5):
295-306.
McGraw hill (2012). Cash Management, Part seven(7)
Nevine Sobhy Abdel Megeid (2013). The impact of effective credit risk management on
commercial banks liquidity performance: case of Egypt: International Journal of Accounting and
Financial Management Research (IJAFMR), Vol 3 Issue 2, 2249-6882.
Sai Kumar Jayanty and Anuradha Mallya. Perspective; Cash Management – An insight
Uwalomwa Uwuigbe, Olubukunola Ranti and Babajide Michael (2015). Credit Management
and Bank Performance of Listed Banks in Nigeria: Journal of Economics and Sustainable
Development ISSN 2222-1700 (Paper) ISSN 2222-2855 (Online) Vol.6, No.2
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