LIQUIDITY MANAGEMENT IN COMMERCIAL BANKS (A CASE STUDY OF FIRST BANK)

CHAPTER ONE

1.0  BACKGROUND OF STUDY

1.1  INTRODUCTION

In every system, there are major components that feature paramount for the survival of the system. This is also applicable to the financial system. The banking institution 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 (Wilner,2000).

In the performance of this financial inter-mediation role, the financial institutions have proved to be an effective channel between savers and borrowers. Among the financial institutions that make themselves available for this all-important role are merchant banks, savings banks, the Central bank, 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 well desired 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 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.

Liquidity management is an important aspect of monetary policy implementation, while the other integral component of monetary policy, i.e. economic management, involves promoting sustainable economic growth over the long term by keeping monetary and credit expansion in step with an economy’s noninflationary output potential, liquidity or reserve management as a shorter time horizon. In order to maintain relative macro-economic stability, reliance is placed on liquidity management to even out the swings in liquidity growth in the banking system.

An important step towards market oriented policy procedures takes place when the Central bank assumes responsibility for evening out swings in demand relative to demand on its own initiative, rather than waiting passively for individual banks to come to it. Once it begins to supply or absorb liquidity through market intervention, the discount window plays an important, but subordinate safety valve role by providing the short-run reserve needs of the banking system for purposes of meeting short term liquidity obligations.

In the financial intermediation process, a bank collects money on deposit from one group (the surplus unit) and grants it out to another group (the deficit unit). These roles involve bringing together people who have money and those who need money.

Apart from the technical aspects of the CBN’s responsibility discussed above, it is important in this section to highlight certain critical factors that are required to facilitate liquidity management in the context of autonomy. These include a stable macroeconomic environment, a sound and competitive financial system, adequate regulatory and supervisory framework, and capacity build up.

Stable Macroeconomic Environment to enhance liquidity management and ensure macroeconomic stability, there is the compelling need to insulate monetary policy from the pressure of financing the government fiscal deficit. Also, the monetary authorities should have freedom in the management of interest rate in order to sufficiently influence transactions in the intervention securities and enhance the effectiveness of instruments for liquidity management. Uncontrolled financing of the deficit by the CBN, either through ways and means advances or the absorption of unsubscribed government debt issues, increase bank liquidity thereby constraining the effectiveness of instruments for liquidity management (Amarachukwu Ona,2003)

Under the new dispensation, sustaining monetary stability will be achieved through greater coordination between the CBN and the Federal Ministry of Finance, in order to limit government borrowing from the bank to the level stipulated by law.

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