Liquidity is an essential part of almost all business operations and cuts across every industry or business sector

Etudes

Liquidity is an essential part of almost all business operations and cuts across every industry or business sector, from manufacturing to retailing, services and most importantly the financial sector. One of the areas that receives much attention in the financial sector is liquidity management. Assets that can be easily converted to cash to meet maturing obligations and unplanned customer withdrawals.
Liquidity is the ability of a company to meet its short-term obligations as and when they fall due. The ability of a business to convert its assets easily into cash could be the difference between a profitable company and a failing one, especially in the financial sector. A company that cannot pay its creditors on time and continues to default on its obligations to those that supplies it goods, credit and other services could be heading towards failure.
Liquidity is important for all business, but even more importantly to businesses in the financial sector, especially commercial banks in Ghana. The creation of liabilities on banks through the collection of deposits and other investment products from the public imposes an obligation on these banks to maintain a level of liquidity that is good enough to meet its obligations, whiles not affecting its profitability negatively. The tradeoff between meeting its obligations and profitability could be the determining factor between profitable and loss-making banks.
The ability of banks to settle their obligations with immediacy, when they fall due, is defined as funding liquidity of the banks (Drehmann & Nikolaou, 2013) .
and failure of a bank to meet its obligations may lead to bank run, a shout of “bank run” may evoke even greater fear. Not only will depositors walk, jog, and run to the affected banks to withdraw their funds, but depositors at other banks, not subject to the same bad news, may also run on their banks as bank runs are frequently viewed as contagious (Kaufman, 1987).The effect of bank runs on a bank will not have consequences on the banks alone but can also cause severe economic damages (Diamond & Dybvig, 2000).Banks are very important players in financial intermediation, as they are responsible for the transfer of funds from surplus units to deficit units. Thus, banks form a key part of the financial system by facilitating the efficient flow of funds achieved by bringing savers and borrowers together. The process of transferring funds from surplus economic units to units having investment opportunities (i.e. the process of converting illiquid assets to liquid liabilities) is known as liquidity creation by banks and this process influences the smooth functioning of the economy (Berger & Bouwman, 2009)). Apart from liquidity, other factors that determine a bank’s profitability may include poor expense management (Kosmidou, 2008).The relationship between profitability and liquidity however has varying degree of results. (Kosmidou, 2008) found that, the relations between liquidity and return on average assets is negative and only significant when you consider only bank’s characteristics, while it becomes positive but insignificant when the macroeconomic and financial structure variables are considered (Ibe, 2013). (Bourke, 1989) also found a significant positive relationship between liquidity and bank profitability whiles (Lartey, et al., 2013) found a weak positive relationship between liquidity and the profitability of the listed banks in Ghana, (Mwizarubi, et al., 2015) also noted that, there is no statistically significant relationship between a bank’s profitability and liquidity in the case of Tanzanian banks.
Profitability in its simplest form refers to the amount of income over and above the cost or expense incurred in generating these revenues. Profitability of companies can be measured using various accounting metrics and ratios. Accounting ratios as a measure of profitability includes; return on assets, return on capital employed, net interest margin and many others. Measures of after-tax rates of return may include the return on average total assets (ROA) and the return on total equity (ROE), and these are used to assess the performance of firms, including commercial banks. These metrics can be affected by so many factors including tax laws and regulations. An important factor affecting the profitability of a bank is the composition of its assets, which invariably could influence both liquidity and profitability.
Problem Statement
The Bank of Ghana in 2017, directed all banks in Ghana to increase their minimum capital from GHC120 million to GHC400 million by December 2018. This directive followed the announcement of the collapse of two banks in the country. The Bank of Ghana also issued corporate governance directive whiles intensifying its supervisory role to make sure that banks are adequately managed and are liquid. Notwithstanding these measures, five local banks also collapsed in 2018 and were subsequently merged to form a new bank.
A lot has been said about the reason(s) for the recent collapse of local banks in Ghana, with various assertions ranging from high non-performing loans, poor corporate governance, poor investment decisions, lack of proper risk management and liquidity challenges. These developments coupled with recent series of failures in the Ghanaian financial sector in general have resulted in the call for proper management of liquidity in financial institutions and adequate checks and controls . The major reason that have accounted for the failure in the sector is largely attributable to liquidity challenges and the eventual “bank run”. (Eljelly, 2004) stated that, profitability and liquidity have become effective indicators of the financial and corporate health and performance of not just commercial banks but many other companies.
Shareholders will be interested in how well the bank is performing in terms of its profitability, whiles the public and customers will also be interested in the ability of the bank to meet their withdrawal requirements. To achieve their role as one of the key players in financial intermediations, a bank will have to be both profitable and liquid. Failure to maintain a healthy liquidity and profitability could lead to serious challenges for any bank and could also have related economic challenges. Liquidity management and profitability in commercial banks are two sensitive issues in the operations of commercial banks of which information on them are seriously hoarded (Olaganju, et al., 2011).
Some of the factors that accounts for bank failures includes; Credit Risk, Operational risk, Market risk, and Liquidity risk. The major cause of the recent bank failures in Ghana is rooted deeply in credit and liquidity risk and corporate governance issues. Reasons cited for the recent collapse of banks in Ghana, especially Unibank includes liquidity shortfalls which resulted in the bank consistently breaching its cash reserve requirement. The bank therefore had to rely on liquidity support of more than GHS 2.2 billion from the Bank of Ghana over the past two years to help meet its liabilities. There were serious liquidity risk exposure and most of the banks did not undertake serious Assets Liabilities Management (BoG, 2018).
The Bank of Ghana also indicated that, Unibank and Royal bank had non-performing loans (NPL) of 89% and 78.79% respectively. (Etale, et al., 2016), studied the impact of NPL on bank performance in Nigeria and concluded that, non-performing loans had a negative impact on the profitability of banks in Nigeria and that any increase in the volume of non-performing loans would reduce profitability of banks in the long run in Nigeria. The reasons for the collapsed of banks in Ghana could therefore be grouped into credit risk and liquidity challenges, with liquidity been the major reason for the failures in most cases, coupled with other corporate governance issues.
This study therefore seeks to determine how liquidity affects profitability of commercial banks in Ghana, since liquidity is of importance in banking operations, the study will therefore try to understand whether liquidity has any effect or impact on profitability of commercial banks in Ghana and whether it should be of strategic importance to managers of banks.
Objectives of the Study
It is the aim of this study to determine the effect of liquidity on profitability of commercial banks in Ghana and to assess whether liquidity management should be an important function in commercial banking, Specifically, the study seeks to:
To examine the liquidity position of Ghanaian banks
To ascertain whether liquidity positions differ between local and foreign banks.
To determine the effect of liquidity on profitability of commercial banks in Ghana
Research Questions
The researcher will seek to answer the following questions;
What is the liquidity position of Ghanaian banks?
Does liquidity the liquidity position differ between local and foreign banks?
What is the effect of liquidity on profitability of commercial banks in Ghana?
Significance of the Study
The banking sector is a vital part of every economy and when it is functioning poorly, the economy in general will feel the impact, since the general financial systems contributes to economic development which further translates to improvement in living standards. Having gone through the literature available, the researcher found that, there are a few studies on how liquidity affects a bank’s profitability in Ghana and these studies covered periods where the financial sector was generally stable. To the best of the researcher’s knowledge, these studies mostly focused on only listed banks in Ghana, which are currently 8 out of the 34 commercial banks in Ghana. This study will consider the effect of liquidity on profitability of commercial banks in Ghana and the general liquidity position of Ghanaian banks, with special interest in how the liquidity position of banks operating in Ghana differs in terms of ownership, i.e. Local and foreign owned banks.
This study will also be of importance to the government, customers, investors and the central bank of Ghana. Banks play very important economic functions such as granting of loans to businesses to increase productivity which will in turn translate into general economic growth. To play this function of financial intermediation, banks will have to be both liquid and profitable, this study will therefore help governments to determine if Ghanaian banks are in a good position to assist in the government’s development agenda.
Liquidity management is a very important function in banking, the central bank expects banks to have some level of liquidity, whiles customers also want to be able to walk into banks to withdrawal money anytime, investors however will also want a return on their investment, all these various interests should be considered and balanced by a bank in determining the appropriate level of liquidity to keep. The study will determine whether liquidity has any effect on a bank’s profitability. This will help investors to plan their investments and the central bank to also determine the appropriate level of liquidity that banks should hold since it could impact their profitability.
Limitations of the Study
The major limitation of this study is the unavailability of the data required for the research. For the research to be profound and have predictive value, the number of banks to be included in the study should have been more, this would have helped the researcher to explore extensively and to cover many years. Because a lot of the banks have been in operation for just a few years and only a few are listed on the Ghana stock exchange, including all the banks operating in Ghana would have been difficult. Notwithstanding this challenge, the sample size was representative enough for the study.
Scope of the study
The scope of the study will be limited to the effect of liquidity on profitability of commercial banks in Ghana. This will comprise both listed and non-listed banks and the differing liquidity positions between local and foreign owned banks. The study was limited to a total of 21 out the 36 licensed banks in Ghana as at June 2017 and covers a period of nine (9) years starting from 2007 to 2015.Out of the 21 banks used for the study, 8 are locally owned banks whiles 13 are foreign owned banks. The length of the study was arrived with by considering the number of years and the availability of data for the selected banks. The selected period was however very significant since it includes the global financial crisis (2007/2008) which provides a unique case for analysis.
Organization of the Chapters
This research will be organized into five chapters, with chapter one providing the introduction to the study, whiles chapter two will try to review the existing literature on the subject, both theoretical and empirical review will be carried out. Chapter three will highlight the methodology; research design, population, sampling method and the sample of the study. Chapter four will discuss the data and the result of the study and will provide the needed interpretation and discussion of the result in line with the existing literature and research questions and objectives. Chapter five will provide a summary of the finding and recommendation for further research. References and an Appendix will also be included.

CHAPTER TWO

LITERATURE REVIEW
Introduction
In this chapter, the literature in the areas of liquidity and bank profitability will be reviewed as well as empirical investigations into the relationship between liquidity and bank profitability and how liquidity affects profitability. The literature review syntheses and presents other related research work and materials accompanied by description and comparative analysis of each work. In this chapter, the review of literature presents conceptual and theoretical literature on the subject matter of bank profitability and liquidity, empirical investigations of the relationship between liquidity and profitability of banks.
Overview of the Ghanaian Banking System
The Ghanaian banking sector is governed by The Banks and Specialized Deposit-Taking Institutions Act 2016, Act 930, which serves as the primary statute governing the banking industry in Ghana together with the Companies Code, 1963 (Act 179). This came into force on 14 September 2016 to repeal the Banking Act 2004, Act 673.
In Ghana, banks are categorized as either foreign bank or a local bank. The categorization of banks in terms of ownership is contained in the Banking Law 2004 Act 673 (Amended 2007): which defines a foreign bank as any bank incorporated in Ghana in which less than 60% of the equity share capital is held by Ghanaians and a local/Ghanaian bank as any bank incorporated in Ghana in which at least 40% of the equity share capital is held by Ghanaians
As at the end of June 2018, there were 34 licensed banks operating in Ghana, with 17 of these banks classified as been domestically controlled and the remaining 17 as foreign controlled. The past two years have seen a lot of changes in the Ghanaian banking space. According to the banking sector report (Bank of Ghana, July 2018); Total assets of the banking sector stood at GH¢100.35 billion by end-June 2018, with year-on-year growth in total assets, however, slowing to 15.7 percent in June 2018 from 30.8 percent in June 2017. Growth in investments, which is the largest component of total assets, was 41.1 percent in June 2018 down from 54.9 percent in June 2017.
Deposits also increased from GH¢54.48 billion to GH¢61.78 billion during the period under review whiles non-performing loans fell to 22.6 percent in June 2018 from 23.5 percent in April 2018, NPL for the same period last stood at 2.2 percent.
Liquidity indicators in the banking sector recorded a mixed performance with core liquidity measures (core liquid assets to total deposits and core liquid assets to total assets) declining marginally in June 2018 compared with last year, while broad liquidity indicators (broad liquid assets to total deposits and broad liquid assets to total assets) showed some improvements.
In terms of profitability, the sector recorded profits of GH¢1.22 billion for the first six months of the year, which is about 21.7 percent higher than the profits recorded in the same period last year (Bank of Ghana, July 2018).
Liquidity Management Theories
The Theories of liquidity management are based either asset or liability management. The commercial loan theory, the shiftability theory and anticipated income theory are based on the management of assets whiles the liability management theory is based on the management of liability.
Commercial Loan Theory
The commercial loan theory states that a commercial bank should forward only short-term self-liquidating productive loans to business organizations. This theory outlines that, a bank’s liquidity can be assured so long as the assets of the bank remain self-liquidating, this is however possible only when the bank restricts itself to financing movements of goods through successive stages of production and consumption (Bhattacharya, 2011).Criticisms against this theory includes that, it is inconsistent with the demands of economic development for developing countries since it excludes long term loans (Dodds, 1982) , but only focuses on financing inventories held in the production process namely, raw materials, work-in-process, and finished goods, and in the final sale of goods namely, debtors (Bhattacharya, 2011)
Subscribing therefore, to the commercial loan theory implies a failure to see beyond the classification of deposits-savings deposits, current accounts, term deposits-and notice the inherent stability of a significant part of such deposits, which could as well be deployed long-term.
Shiftability Theory
The obvious shortfall in the commercial loan theory lead to the shiftability theory. Shiftability theory therefore aims to keep banks liquid through the shifting of its assets, thus illiquid banks become liquid by selling their assets to a more liquid bank. This theory holds that if banks hold assets that could be ‘shifted’, that is, transferred or sold for cash, banks would continue to be liquid (Bhattacharya, 2011). It stresses the need for banks to hold liquid government securities, that are easily transferable to the central bank for cash when the bank experiences liquidity challenges.
According to the shiftability theory, banks would insist on borrowers to put in readily saleable collaterals in addition to principal assets like inventories and debtors so that when the loan or loan assets become sticky, the banks can sell the collaterals (Bhattacharya, 2011)
Anticipated Income Theory
The Shiftable theory gave rise to a security oriented approach in lending which does not support entrepreneurial ventures where collaterals are not available, though the venture has the potential to generate enough cash flows to repay the debt (Bhattacharya, 2011).Unlike the commercial loan theory and the shiftability theory, the anticipated income theory holds that, the liquidity of a bank or financial institution can be ensured if scheduled loan repayments are made with consideration to the future income of the borrower. It tries not to focus the repayment of loans on the future income of the borrower rather than on collateral. Under this theory, emphasis should be placed on the viability and growth or income generating potential of a business rather than the collateral it can provide, because if a business fails, no amount of security would be able to cover the loan when such collaterals are sold. It is necessary, therefore, to install proper monitoring and follow-up systems as a part of credit management of banks (Bhattacharya, 2011).
Asset Liability Management Theory
The Society of Actuaries defines Asset Liability Management (ALM) as the ongoing process of formulating, implementing, monitoring and revising strategies related to assets and liabilities to achieve an organization’s financial objectives, given the organization’s risk tolerances and other constraints (Society of Actuaries, 2003). Assets, liabilities, and risks have definitions that are mostly specific to each institution, but, very generally, assets may be classified as expected cash inflows, and liabilities as expected cash outflows (Romanyuk, 2010).
ALM have traditionally focused on the risk associated with changes in interest rates, but now considers a broader range of areas including equity risk, legal risk, currency risk and sovereign risk. ALM theory looks at the need for banks to look at borrowing reserve money in the market whenever necessary than lending self-liquidating loans and maintaining liquid assets. Asset/liability management therefore involves managing the use of assets and cash flows to meet a company’s obligations to guard against the risk of loss from not paying a liability on time. A good balance could make the company profitable. Thus, ALM focuses on the timing of cash flow and the needed to determine when liabilities will have to be settled and whether the required assets are available to settle them on time.
The Concept of Liquidity
Defining liquidity is a difficult task because it has different meanings, connotations and measurement to different parties and organizations .However liquidity could be seen as the ability and ease of businesses especially banks to convert their assets to cash (Bordeleau ; Graham, 2010). (Shim ; Siegel, 2000), however defined liquidity as the firm’s capacity to liquidate maturing short term debt (within one year) and the maintenance of adequate liquidity is much more than a corporate goal. Maintaining adequate liquidity could ensure a firms’ continuity and lack of it could spell doom for a firm. A bank’s liquidity is determined by its ability to meet all its anticipated expenses, such as funding loans or making payments on debt, using only liquid assets. Ideally, a bank should maintain a level of liquidity that also allows it to meet any unexpected expenses without having to liquidate other assets (Boyte-White , 2017).
Banks with large liquid assets compared to its liability or anticipated liability are said to be more liquid. Banks must meet their due obligations and make payments when these obligations are due, otherwise, they stand the risk of being declared illiquid (Crockett, 2008).

Liquid assets are those that can be converted into cash quickly if needed to meet financial obligations; examples of liquid assets include cash, central bank reserves, and government debt. To remain viable, a financial institution must have enough liquid assets to meet its near-term obligations, such as withdrawals by depositors (Bassey & Moses, 2015).The main measures of liquidity are current ratio, capital ratio, cash ratio, quick ratio, investment ratio.
A business unit can only grow focusing on its inner strengths to exploit the opportunities in the market. Consequently, the best definition as opined by (Tsomocos, 2003) should be adopted from a survival growth perspective as business unit should think of surviving before making profit. Again, optimizing profit involves two variables; revenue and cost. The issue of profitability is a continuous issue that a company must consistently make. Essentially, profitability is concerned with the level of turnover that must be achieved to cover costs and make surplus. Corporate profitability may be improved through ratio analysis, breakeven analysis, marginal analysis, cost control or through financial control. It is therefore, necessary to mention that whether a bank is planning for profit or taking steps to improve its profitability, it must ensure that it has adequate liquidity to transact business and finance operations. If the plan is to improve or increase profitability by increasing the income level, the bank must be able to determine the financing needs for the new income level.
Elements of Liquidity
The liquid assets of a company are those assets that can be converted to cash easily when the need arises. To most business their liquid assets will include; cash, government securities and other marketable securities such as bonds and stocks. The degree of liquidity however differs, a savings or time deposit is considered more liquid than common stock and common stocks and stocks are also considered liquid that immovable properties such as building. Liquidity therefore is a relative concept since there is no specific means of measuring how liquid a firm is. Liquidity involves three elements or characteristics namely marketability, stability and conservatism (Tsomocos, 2003).
Market liquidity refers to a market’s ability to allow assets to be bought and sold easily and quickly, such as a country’s financial markets or real estate market (Mueller, 2018), Liquid assets are therefore expected to be more marketable and transferrable. This means, they are expected to be converted to cash easily and promptly.
Assets that cannot be redeemed easily on maturity without a substantial loss in value are deemed illiquid. Another quality of liquid asset is price stability. Based on this characteristic, bank deposits and short-term securities are more liquid than equity investments such as common stocks and real estates since the prices of the former are fixed and have lesser variability than the prices and value of the later that experience considerable fluctuation (Tsomocos, 2003).
Conservatism quality of liquidity refers to the ability of the holders of liquid assets to recover the cost of the asset at the time of resale. On the basis, common stocks are not considered highly liquid asset even though they are mostly tradeable.
Double coincidence of wants is one of the problems that made trade by barter unpopular and lead to its replacement with money. Because all other assets are convertible into money before they are used and because money ensures that an asset is converted to any other assets, money becomes the most popular liquid asset with high rate of convertibility.
Profitability
There are many definitions in relation to profitability, but this study adopts the definition given by (Niresh, 2012). According to (Niresh, 2012), profitability is defined as a measure by which a bank’s revenues exceed its relevant expenses. The study furthermore suggested that, strong earnings and profitability profile of a bank reflects its ability to support present and future operations and how best it can absorb future contingent shocks and build resilient capacity. A low profit could suggest ineffective management and poor usage of resources or assets to generate revenue, meaning investors would be hesitant to invest in the bank. Although there are various indicators of earnings and profitability, the most representative and widely used is the return on assets (ROA), in addition to the return on equity (ROE) and net interest margin (NIM). ROA is primarily an indicator of managerial efficiency and it indicates how capable the management of a bank has been in converting the institution’s asset into net earnings. ROE measures the rate of return that a bank’s shareholders will earn from their investment. The net interest margin (NIM), looks at the ratio of a bank’s net interest income to the average interest earning assets or it measures how successful a firm is in investing the funds it receives in relation to the cost associated with these funds. The NIM is therefore one of the most important indicators for a bank’s operations and profitability.
Measuring Profitability
(Gilbert ; Wheelock, 2007) recognized that, measures of after-tax rates of return, such as the return on average total assets (ROA) and the return on total equity (ROE), are widely used to assess frim performance, including commercial banks. Profitability may be defined as the ability of a given investment to earn a return from its use (Tulsian, 2014), it is the final measure of economic success achieved by a company in relation to the capital invested in it (Pimentel, et al., 2010). The economic success (profitability) is determined by how much net profit has been achieved in relation to the amount of risk shareholders are willing to accept. Profitability and risk are major components of business operations. Profitability is the primary objective of most businesses, without it most of them will not survive. Measuring probability therefore becomes the most important measure of how successful a business is or will be and its ability to provide the needed return on investments.
The measurement of how profitable a business is mostly done through the Return on Asset (ROA), which is measured as (Net Income / Total Assets) and the Return on Equity (ROE), which is also measured as (Net Income / Equity), this measures how well the resources of a company have been applied in generating economic benefits (Vieira, 2015)
(Alghifari, et al., 2013) noted that, performance factors that are focused on the financial aspects of performance uses return on asset as proxy. Return on Assets (ROA) is therefore a measure of the overall effectiveness of management in generating returns to ordinary shareholders with its available assets (Megginson, et al., 2008).The return on asset measures the firm’s ability in creating profits using its available assets. It is computed as the ratio of net income to the average assets of the company during the year. The net income is the amount of the firm’s income that is available for distribution to the shareholders of the firm. Average asset is the average of all assets at the start and the end of the financial year of the firm that are used in the production of the income. ROA is useful number for comparing competing companies in the same industry, it helps to see which company is on the average returning more in relation to the assets employed in revenue production. The number will vary widely across different industries. Return on assets also gives an indication of the capital intensity of the company, which will depend on the industry; since different industries will use assets differently and generally, companies that require the investment of large initial capital will have lower return on assets.
Return on equity (ROE) is treated as an important measure of a company’s earnings performance. The ROE tells common shareholders how effectively their Money is being employed (Kijewska, 2016). (Maheshwari & Maheshwari, 2009) defines ROE as the ratio that compares the amount of profit for the period available to the owners with the owners’ average stake in the business during that same period. It measures how well profit have been made in relation to the capital the owners have invested in the business. It is normally expressed as a percentage of profit for the year less any preference dividend divided by the value of the ordinary share capital and reserves. The profit is what is available for the owners after all the required deductions have been settled. To make the ratio more representative, the average of the shareholders’ fund is mostly used in its calculation.
For a company to survive and grow, it should be able to make profit or have the potential to make profit (Owolabi & Obida, 2012). They further stated that profits are an important part of every manager’s plan and is very essential to the survival of companies, but all management decision should not be profit centered at the expense of the concerns for stakeholders such as customers, employees, suppliers or social consequences. (Owolabi ; Obida, 2012) further stated that, profit is the difference between revenues and expenses over a period (usually one year). Most companies exist to make profit and to survive, but a company may not survive if it fails to make enough profits. Some of the profitability ratios include the following:
Return on Equity (ROE)
The ROE is what informs shareholders on how effectively their money is being used in the generation of revenue. With it, one can determine whether a firm is a profit-creator or a profit-burner and management’s profit-earnings efficiency (Kijewska, 2016). The return on equity is the ratio of net profit after taxes divided by equity capital, which means that, the lower the equity capital, the higher the ROE. To generate higher ROE will therefore mean lower capital which is ideal for shareholders, but Equity capital can however not be too low since the banks’ capital is subjected to the capital adequacy regulations. In Ghana, banks must always maintain a minimum capital adequacy ratio of 10% while in operation. (Banking Act, 2004 Act 673, section 23(1).
Return on equity (ROE) is the amount of net income returned as a percentage of shareholders’ equity (Ahsan, 2012). It measures the amount that the firm is earning on shareholders’ investments. The rate of dividend is not fixed; the gains made may be distributed to shareholders or retained or ploughed back into the business. Notwithstanding, the net profit after tax represents their return. A return on shareholder ‘s equity is calculated to measure how much profit is generated from the resources given to a frim by the shareholders. The shareholders’ equity or net worth will include paid up share capital, share premium reserves and surplus less accumulated losses. The ROE is therefore the net income divided by the shareholders’ fund.
Return on Assets (ROA)
Return on Assets expresses the net income earned by a company as a percentage of the total assets available for use by that company (Owolabi & Obida, 2012). Companies with large asset base are therefore expected to earn higher income. ROA measures management ‘s ability to earn a return from use of the firm ‘s resources (assets). It provides information about how much pro?ts are generated on average by each unit of assets used and therefore serves as an indicator on how ef?ciently a bank is being run (Petersen & Schoemam, 2008).The computation of ROA therefore may use the net income after tax and add interest expense since interest is the return to creditors for the resources that they provide to the firm. Therefore, considers the amount before distribution to providers of capital. The ROA is computed by as net income plus interest expense divided by the company’s average investment in asset during the year.
Consequently, a positive return on asset means that, the company is making a return from its assets and there could be room for capital growth. Conversely, a negative ROA would mean that the company suffers a loss from the use of the asset, which means further capital cannot be introduced whiles the current on is making losses.
Relationship between Liquidity and Profitability
A study by (Al Nimer, et al., 2015) investigated the impact of liquidity on Jordanian banks profitability through return on assets for the period 2005-2011. Their study concluded that at a 5 percent level of significance, quick ratio has an impact on profitability represented by ROA. Similarly, (Agbada ; Osuji, 2013) also studied how liquidity management affects banks profitability and their findings showed that there is a significant relationship between efficient liquidity management and banking . (Macharia, 2013) also explored the relationship between profitability and liquidity of 44 commercial banks in Kenya during 2008-2012. The study also concluded that, though liquidity was not a significant determinant of commercial banks profitability, the relationship between liquidity and profitability was positive and that liquidity was one of the determining factors of profitability.
(Bordeleau ; Graham, 2010), (Ibrahim, 2017), (Bourke, 1989), (Kosmidou, et al., 2005) and (Olaganju, et al., 2011) all found some level relationship between liquidity and profitability in their studies. Liquidity management plays and important role in a firms’ risk, profitability and its overall value and it is therefore essential to manage its short-term assets and liabilities carefully since they mostly determine the liquidity of businesses. (Smith, 1980).
Efficient management of liquidity plays a crucial role in business management and is an important part of the overall corporate strategy in creating the shareholder’s value (Afza ; Nazir, 2011). Liquidity management is a simple and straightforward concept of ensuring the ability of the organization to fund the difference between the short-term assets and short-term liabilities and will mostly involve maintaining an optimal balance between each of the working capital components.
(Ben-Caleb, et al., 2013) investigated the relationship between liquidity and profitability of 30 manufacturing firms listed on the Nigerian stock exchange and their result suggests that current ratio and liquid ratio is positively associated with profitability while cash conversion period is negatively related with profitability.
Empirical Evidence
The studies on the impact/effect of liquidity on profitability has mixed results, whiles some findings suggest a relationship between the two, others do not find any relationship between liquidity and profitability. Whiles some also suggests that, liquidity affects profitability, conversely other studies concluded that liquidity do not affect or impact liquidity in anyway whiles some studies also produced mixed results. This is expected because holding liquid asset implies a low liquidity premium and, therefore, a lower return compared to illiquid assets and that, there is a certain point after which holding so much liquid assets may affect a bank’s profitability (Bordeleau & Graham, 2010)
(Bordeleau & Graham, 2010) reviewed the impact of liquidity on bank profitability for 55 US banks and 10 Canadian banks between the period of 1997 and 2009. Results from their study suggested that a nonlinear relationship exists, whereby profitability is improved for banks that hold some liquid assets, however, there is a point beyond which holding further liquid assets diminishes a banks’ profitability, all else equal. Conceptually, this result is consistent with the idea that funding markets reward a bank, to some extent, for holding liquid assets, thereby reducing its liquidity risk. However, this benefit can eventually be outweighed by the opportunity cost of holding such comparatively low?yielding liquid assets on the balance sheet. At the same time, estimation results provided some evidence that the relationship between liquid assets and profitability depended on the bank’s business model and the risk of funding market difficulties. Adopting a more traditional i.e. deposit and loan?based business model allows a bank to optimize profits with a lower level of liquid assets. Likewise, when the likelihood of funding market difficulties is low, banks need to hold fewer liquid assets to optimize profits. (Bourke, 1989) in the study on performance of banks in Europe, North America and Australia found evidence that there is a positive relationship between liquid assets and bank profitability. Similarly, (Ibrahim, 2017) studied the impact of liquidity on profitability of commercial banks in Iraq through regression analysis. He concluded that, all the liquidity variables used for the study had a positive effect on return on assets. (Kosmidou, et al., 2005) studied how bank-specific characteristics, macroeconomic conditions and financial market structure on UK owned commercial banks impacted their profitability, during the period 1995-2002.The study measured liquidity through the ratio of liquid assets to customer and shot term funding and concluded that liquidity has a positive effect on Return on Average Asset (ROAA), this is further confirmed by recent studies by (Olaganju, et al., 2011) who explored the impact of liquidity on commercial banks in Nigeria. They also concluded that, liquidity significantly influences profitability and as such the profitability of commercial banks in Nigeria is affected by their liquidity.
(Owolabi, et al., 2011) investigated the relationship between liquidity and profitability in 15 selected quoted companies in Nigeria. The main objective was to examine the nature and extent of the relationship between liquidity and profitability in profit-driven quoted companies and to determine whether any cause and effect relationship existed between the two performance measures. Liquidity measures considered was current assets- liabilities ratio while profitability measure was operating profit-turnover ratio. The results showed that while a trade-off existed between liquidity and profitability in the banking company, the two variables were positively correlated and reinforced each other in the other companies.
(Zainudin, 2006) studied the liquidity profitability trade off to get evidence from Malaysian SMEs by using data extracted from their annual financial statements, from 1999 to 2003. A total of 145 SMEs in the manufacturing sector were studied. Their study confirms that there is a moderate positive relationship between profitability and liquidity and that liquidity levels varies from industry to industry and even from one company to another depending on that company’s size. The study also revealed that profitable firms tend to have high levels of liquidity.
(Ehiedu, 2014) documented the impact of liquidity on profitability of selected companies in the industrial/Domestic products” industry; that are quoted on the Nigerian Stock Exchange (NSE) through simple correlation analysis and concluded that, there is a significant positive correlation between current ratio and profitability whiles there is no definite significant correlation between Acid-test ratio and profitability.
Notwithstanding the literature on the positive relationship between liquidity and profitability, other studies however found negative relationship and insignificant or no impact of liquidity on profitability.
(Mwizarubi, et al., 2015) examined the relationship between banks’ profitability and liquidity from 2006 to 2013. By using Hausman test and thereafter fixed effects approach, they concluded that, there is no statistically significant relationship between banks’ profitability and liquidity and that banks should focus on increasing their profitability without affecting their liquidity. (Macharia, 2013) also explored the relationship between profitability and liquidity of 44 commercial banks in Kenya from 2008-2012 and concludes that profitability and liquidity have a positive relationship and that liquidity is not a significant determinant of commercial bank’s profitability. (Mensah & Awah, 2015) also concluded that, profitability of listed banks in Ghana is not affected or influenced by their liquidity, this is further enforced by (Ware, 2015) who measured the relationship between liquidity and profitability and its effect on profitability using data from all the 33 companies listed on the Ghana Stock Exchange (GSE). The finding shows that liquidity measured in terms of the Cash Conversion Cycle, Average Collection Period and Average Payment Period have no statistically significant effect on profitability.
(Niresh, 2012), analyzed the tradeoff between liquidity and profitability of 31 listed manufacturing firms from 2007-2011 in Sri Lanka. He concluded that, there is no significant relationship between liquidity and profitability among the listed manufacturing firms in Sri Lanka. (Eljelly, 2004) also, further confirmed this in a study on the relationship between liquidity and profitability of 29 corporations in Saudi Arabia from 1996-2000.He indicated that, there is a negative and significant relationship between profitability and companies’ liquidity. A study carried out on the relationship between liquidity management and company profitability and value for Japanese and Taiwanese companies for the period 1985-1996 by (Wang, 2002) noted that, there is a negative relationship between cash conversion cycle and profitability indices (equities return ratio and assets return ratio) and that that aggressive liquidity management (reducing CCC) could enhances operating performance.
(Alshatti, 2014) studied the impact of liquidity on profitability of Jordanian banks from 2005-2012. The study used investment ratio, quick ratio, capital ratio, net credit facilities/total assets and liquid assets ratio as the liquidity indicators and return on equity (ROE) and return on assets (ROA) as the proxies for profitability. The results show that an increase in the quick ratio and the investment ratio leads to an increase in the profitability however, an increase in the capital ratio and the liquid assets ratio leads to decrease in the profitability.
Summary of Literature Review
The existing literature reveals that there is a relationship between liquidity and performance of not only banks but other businesses. The results are however mixed with a substantial number of studies suggesting a relationship and an impact of liquidity on profitability and others also suggesting that there exists no relationship between liquidity and profitability and that liquidity do not directly affect profitability. There are so many measures of liquidity and different studies applies or uses different measures of liquidity and the concept of liquidity though important is mostly subjective and differs from company.
Using Pearson correlation data analysis, (Olaganju, et al., 2011) examined the relationship between liquidity and commercial bank profitability in Nigeria and their findings from the testing of their hypothesis indicated that there is significant relationship between liquidity and profitability. (Lartey, et al., 2013) found similar positive ratio between liquidity and profitability of listed banks in Ghana, though the relationship was weak. They sought to find the relationship between liquidity and profitability of listed banks in Ghana through and determined the trend in liquidity and profitability were determined using time series analysis.
(Marozva, 2015) studied liquidity and bank performance in South Africa and using Autoregressive Distributed Lag (ARDL)-bound testing approach and the Ordinary Least Squares (OLS) he examined the connection between net interest margin and liquidity and concluded that there is a significant deterministic relationship between net interest margin, funding liquidity, and that, there is insignificant long run relationship between bank performance and liquidity.
While a lot of studies have been done on the effect of liquidity on profitability of commercial banks, majority of these studies were done in developed countries. This research will therefore contribute to the literature on the effect of liquidity on profitability in developing countries.

CHAPTER THREE

METHODOLOGY
Introduction
This chapter presents the source of data, the measurements of the variables for the study and their effects. It also discusses the estimation strategy used and concludes with the model specification. This helps us to achieve the objectives of the study set out in chapter one.
Data
To investigate the effect of liquidity on the profitability of banks in Ghana, data on bank specific characteristics were gleaned from the Ghana Banking Survey 2016 and Bankscope database with the essential of the data coming from the various banks’ statement of financial position and income statement. Bankscope is complete, global database having information on almost 30,000 public and private banks globally and is sustained by the International Credit Analysis Limited (IBCA).
To attain viability of the study, the sample period chosen was between, 2007-2015. This period entails the period of the global financial crisis (2007/2008) which represents a unique time of credit crisis. This study represents only universal banks operating in Ghana during the study period. Other sources of data include journals, survey reports, website, past dissertations and text books.
Population
A population is the set of all measurements of interest to the sample collector (Ott & Longnecker, 2015) The population of the study is made up of all the 34 banks currently operating in the Ghanaian banking space. The population will be limited to commercial banks and includes both listed and unlisted banks. According to the Bank of Ghana, there are currently 34 licensed banks operating in Ghana as at June 2018 (Bank of Ghana, July 2018).
Sample Size
A sample is any subset of measurements selected from the population (Ott & Longnecker, 2015). The sample initially contained all 34 banks, but subsequently, banks that do not report data on the dependent variables employed in the analysis, were excluded. Finally, an observation of 21 banks yielding a maximum of 168 unbalanced bank- year observations were used for the study.
The number of banks selected for the study were 21 out of the 36 banks in Ghana as at June 2017. This number was arrived at purely based on data availability and taking into consideration the number of years the study will cover. Eight (8) local banks and thirteen (13) foreign banks were selected for the study. The selected banks include; Agricultural Development Bank (ADB), Bank of Africa Ghana Limited (BoA), Barclays Bank of Ghana Ltd (BBG),BSIC Ghana Ltd (BSIC), Cal Bank Ltd (CAL), First Atlantic Bank Ghana (FAB),Ecobank Ghana (EBG), Fidelity Bank Limited (FBL), FBN Bank Ghana Ltd (FBN), GCB Bank Limited (GCB), Guaranty Trust Bank (Ghana) Limited (GTB), Republic Bank (Ghana) Ltd (RBL), National Investment Bank Ltd, (NIB), Prudential Bank Limited (PBL), Stanbic Bank Ghana Ltd (STB), Standard Chartered Bank Gh. Ltd (SCB), Societe Generale Ghana (SGL), United Bank for Africa (Ghana) Ltd (UBA), Unibank Ghana Ltd (UNI), UT Bank (UTB), Zenith Bank Ghana Ltd (ZBG)
Sampling Technique
The study considered all the commercial banks in Ghana and a convenience sampling technique was used in selecting the samples for the study. Convenience sampling (also known as Haphazard Sampling or Accidental Sampling) is a type of nonprobability or nonrandom sampling where members of the target population that meet certain practical criteria, such as easy accessibility, geographical proximity, availability at a given time, or the willingness to participate are included for the study (Dörnyei, 2007). Convenience sampling is used because it is quick, inexpensive, and convenient and allows the researcher to simply use participants who are available now.
Measurement of Dependent Variables
The study uses return on assets and return on equity to measure the performance of the banks in Ghana. These are the two main proxies used.
Return on assets (ROA): Return on asset was used as a measure of profitability or performance of banks. This measure is the dependent variable for the study. (Masood & Ashraf, 2012) employed this indicator in their studies. ROA is a ratio of net income to total assets for the bank. The equation below shows the return on asset measure.
ROA=(Net Icome)/(Total Assets) (1)
Return on Equity: The return on equity measure is a good indicator of management’s efficiency and the banks’ financial performance. It shows how competent managements are in using shareholders’ equity to generate net profit. (Masood & Ashraf, 2012), again, employed this indicator in their study. The higher this ratio, the more profitable a bank is. It is calculated as follows.
ROE=(Net Icome)/(Total Equity) (2)
Measurement of Independent Variables
Liquidity Ratios
Liquidity ratios are used to measure the ability of an entity to meet its short-term obligations as and when they fall due. They help to determine how sound an entity’s financial health is. According to (Molyneux & Thornton, 1992) there is a weak indirect link between liquidity ratios and the levels of profitability of banks. This is not unusual because legal reserves and other liquidity holdings constitute a cost to banks. Inadequate liquidity is one of the main causes of bank failures (Marozva, 2015). In contrast, (Bourke, 1989) found a significant positive relationship between bank liquidity and profitability. Liquidity ratios include the following.
Current Ratio: This ratio is computed as total assets less net book value of fixed assets, less investment in subsidiaries and associated companies divided by the total liabilities less long-term borrowings. Current liabilities consist of customer deposits, accruals and so on. After computing the values, the results are interpreted to guide decision-making. A current ratio that is greater than or equal to one means that the entity is liquid and can meet its short-term obligations as and when they fall due. However, a current ratio of less than one suggests that the bank may have liquidity challenges. The equation below shows the detail measurement.
CR=(Total assets-Net book value of fixed assets-subsidiaries investment )/(Total liabilities-long term borrowings) (3)

Summarized as:
CR =(Current Asset)/(Current Liabilities) (3)
Liquid Assets to Total Deposit: This indicates the amount of liquid assets that are available to depositors and borrowers as well. The higher this ratio the more profitable the bank could be. We therefore expect a positive relationship between liquid assets to total deposit and profitability. Equation 4 below shows the expression for LATD.
LATD =(Liquid Assets)/(Total Deposit) (4)
Cash Ratio: The cash ratio is even more restrictive in the current assets that are used to compute it. Cash and cash equivalents are the only current assets that are used in the computation of the cash ratio. One of the key activities of the bank is the supply of cash on demand, for customers’ withdrawals which is always unpredictable unlike other bills the bank must pay that can be reasonably estimated. Cash equivalents on the other hand are another short-term asset and are called cash equivalents because of the ability to easily convert them to cash. Investments, mostly short term, that can be quickly converted to cash without loss of value, such as demand deposits, T-bills, and commercial paper are examples of cash and cash equivalents. One of the key characteristics of financial instruments that are classified as cash equivalents is that they have a short-term maturity.
The cash ratio is calculated by dividing cash and cash equivalents by current liabilities.
Cash ratio =(Cash and cash equivalents)/(Current liabilities) (5)
Bank size (SIZE): Various methods are available when it comes to measuring firm size. Amongst them are market value of a firm’s equity, sale value of a firm and firms’ total assets. A review of literature disclosed that total assets of a firm is widely used as a proxy for size. Hence this study employs total assets in measuring bank size. Because the value of total assets is greater than other variables, the logarithm of total asset is used to bring it close to other variables. A positive relationship is expected between bank size and profitability. This is because as a bank grows, it is expected that its performance level will increase, thus large banks are expected to be more profitable than smaller banks, this may however not be the case always.
Efficiency: The cost to income ratio is used as a proxy for bank efficiency. We argue that banks that are efficient are more likely to generate more deposit hence their liquidity level could be high thereby making them stable banks. Also, banks that are stable are more likely to be profitable. Hence, we expect a positive relationship between efficiency and profitability.
The cost to income ratio/Operating Expense Ratio is calculated by dividing operating expenses by the revenue
Cost to Income Ratio =(Operating Expenses)/Revenues (6)
Estimation Strategy
Panel regression models were employed in this study. Regression models are appropriate when we want to relate an explained variable to several explanatory variables. As per the nature of the data collected, it was reasonable to employ a panel data methodology. Panel regression analysis entails analysis with “a spatial and temporal dimension” and improves upon the identification of effects that could otherwise have not been detected in pure cross-sectional or pure time-series studies (Bokpin, 2011). He proceeded his arguments by adding that, in using panel data analysis, degrees of freedom are increased, therefore reducing any collinearity among the independent variables whiles increasing the efficiency of financial and economic estimates.
The general form of a panel regression model is specified as follows:
Y_it = ? + ?X_it + ?_(it ) i=1,…,N;t=1,…,T (7)
Where
i stands for the cross-section dimension
t represents the time-series factor.
Y_it is the dependant variable
? is a scalar and ? is the coefficient.
X_it is a vector of explanatory variables and
?_it is the error term.
Empirical Model
To address the effect of bank liquidity on the profitability of banks in Ghana. The following model was estimated.
?PROF?_it=?_0+?_1 ?CR?_it+?_2 ?LATD?_it+?_3 ?CAR?_it+?_4 ?SIZE?_it+?_5 EFF.+?_it (8)
Where PROF. is the measure of profitability for both return on assets and return on equity. CR is the measure of current ratio, LATD is the liquid assets to total deposits and CAR is cash ratio. SIZE measures the size of the bank which is the log of total assets while EFF. is bank efficiency measured as cost to income ratio. The ?_1 to ?_5 are the parameters to be estimated. ?_it is the error term. The equation 8 above is estimated using the Generalized Least Squares (RLS) and effects model.

CHAPTER FOUR

ANALYSIS AND DISCUSSION OF RESULTS
Introduction
This study investigates the influence of liquidity ratios on the financial performance of banks in Ghana. In this chapter, the study presents the results and the analysis of the findings. The study results were presented using tables. The results presentation and analysis of the findings were done in relation to the study objectives. Therefore, this chapter is organized by first presenting the descriptive statistics of the liquidity and firm performance variables and followed by a correlation analysis of the study variables and finally the presentation of regression results depicting the effects of liquidity and control variables on the financial performance of banks.
Descriptive Statistics
In this study, data was collected on 21 banks. The liquidity variables used includes current ratio, liquid assets to total deposit ratio and cash ratio. The firm performance measures used were return on equity and return on asset. In recognition of the fact that there are other factors influencing the performance of banks, the study employed control variables such as bank size measured as the natural logarithm of total assets and efficiency measured by cost to income ratio (consistent with (Marozva, 2015). The descriptive statistics of all these variables are presented in Table 4.1as follows.

Table 4.1 Summary of Descriptive Statistics
Variable Mean Std. Dev. Min Max
ROE 0.205 0.419 -4.399 0.822
ROA 0.030 0.034 -0.171 0.092
CR 1.098 0.173 0.450 2.318
LATD 0.628 0.281 0.157 1.820
CAR 0.505 0.199 0.136 1.508
CIR 0.853 0.225 0.429 2.438
SIZE 5.865 0.477 4.178 6.819

Findings from the descriptive statistics shows that on the average most of the firms appear not to have done well with regards to return on assets. On the average, the banks recorded 3 pesewas in profit for every 1 Cedi of assets employed. Table 4.1 shows that the mean performance in terms of returns on assets for the period is 0.3% with the least performing firm recording as low as -17.1%. However, the banks recorded decent returns on equity with the average return on equity reading 20.5%. It appears there is a substantial variation between high and low performing banks in terms of returns on equity. Within the period 2007 – 2015, while the worst performing bank recorded a ROE of -439.9%, the highest performer recorded 82.2%. Thus, there is a wide deviation between the firms with regards to their performance.
The descriptive statistics revealed that the liquidity variables showed significant variations perhaps due to the variations in structures of the banks. The average current ratio stood at 1.1 while 0.45 was the minimum and 2.32 was the maximum. Within the period, 2007 – 2015, the banks recorded on the average 1.1 Cedis in liquid assets to pay for every 1 Cedi in current liability. With a standard deviation of 0.17, it appears most of the banks are wide apart in terms their current ratios. The average liquid assets to total deposit ratio stood at 0.63 within the study period. The banks thus, had 63 pesewas in liquid assets to pay for every 1 Cedi of deposit. The minimum liquid assets to total deposit ratio read 0.16 while the maximum liquid assets to total deposit was 1.82. The statistic for cash ratio is quite like that of liquid assets to total deposit ratio as the average cash ratio stood at 0.51. The bank with the least cash ratio recorded 0.14 while the maximum cash ratio was 1.51.
The results from the descriptive statistics show that apart from the current ratio, the other liquidity measures recorded an average of less than one (1) over the study period. This may imply that the banks were not able to fully cover their short-term financial obligations. Perhaps the banks might have committed their cash reserves into investment projects which might however, put their financial positions into jeopardy. (Nwankwo, 1991) and (Ben-Caleb, et al., 2013) argue that adequate liquidity is needed to address three risks. First, adequate liquidity positions the banks to readily replace net outflows resulting from “nonrenewal of wholesale funds” or deposit withdrawals thus, enabling the banks to contain any funding risk. Secondly, the risk of inflow of anticipated funds not materializing, is curtailed by enough liquidity. The failure of borrowers to meet their obligations can hamper the funding needs of banks. Thirdly, adequate liquidity enables the banks to honor maturing obligations and the withdrawal request from customers. Hence, the low liquidity position of the banks may not augur well for the confidence of the customers.
The average bank size is 5.87. Bank size ranges from 4.18 to 6.82. With a standard deviation of 0.48, it appears most of the banks are not particularly wide apart. Cost to income ratio was used as the efficiency measure. The average cost to income ratio stood at 85.3%. It appears there is a substantial variation between high and low performance in terms of CIR. While the worst performing bank recorded a CIR of 243.8%, the best performer recorded a CIR of 42.9%. Generally, the banking industry recorded high cost to income ratio within the study period.
Liquidity Position of Ghanaian Banks in Terms of Ownership Structure
The study segregates the banks sampled into foreign and local banks and reviews their average liquidity ratios over the period. The banks are classified as foreign or local depending on the origin/nationality of the majority shareholder or parent company. The results are presented in.

Table 4.2 Liquidity Ratios for Foreign and Local banks
Year Foreign Banks Local Banks
Current Ratio Cash Ratio Liquid Asset/Total Deposit Current Ratio Cash Ratio Liquid Asset/Total Deposit
2007 1.076 0.514 0.635 1.045 0.423 0.545
2008 1.211 0.592 0.732 1.085 0.375 0.533
2009 1.076 0.541 0.644 1.061 0.386 0.500
2010 1.103 0.554 0.623 1.061 0.430 0.543
2011 1.105 0.574 0.641 0.971 0.399 0.455
2012 1.153 0.548 0.622 1.087 0.427 0.497
2013 1.127 0.531 0.751 1.113 0.438 0.531
2014 1.095 0.546 0.756 1.110 0.453 0.605
2015 1.082 0.573 0.723 1.086 0.494 0.642
Generally, the banks maintained stable ratios over the period, witnessing very little fluctuations. The foreign banks generally recorded higher liquidity than the local banks. This may imply that the foreign banks relied less on deposit financing as they maintained greater asset liquidity. The relative financial strength of the foreign banks may suggest that foreign ownership of banks may help to improve the overall strength of the financial system and institutions both qualitatively and quantitatively. The greater asset liquidity provided by foreign banks should help improve access to liquidity and capital within the banking industry and generally enhance the balance sheet strength of the industry. The entrance of foreign banks would be associated with capital inflow and the transfer of skill, knowledge, and technology which should contribute greatly in improving risk management and control within the banking industry.
Having ascertained the current liquidity positions of banks operating in Ghana and the liquidity ratios for local and foreign bank, it is necessary that the study delves into answering whether the observed liquidity positions of banks in Ghana does differ by ownership types i.e. local and foreign. Using the Independent Sample test statistics, the below hypotheses were tested for all the three liquidity indicators used for the study.
H_0= µ_(LATD (local))= µ_(LADT (Foreign)) i.e. LATD of local banks is almost the same as those with foreign ownership. This is tested against an alternative that LATD of local and foreign banks differs. i.e. H_1= µ_(LATD (local))? µ_(LATD (Foreign))
H_0= µ_(Current ratio (local))= µ_(Current ratio (Foreign)) i.e. current ratio is the same for banks irrespective of ownership type. This has the alternative hypothesis H_1= µ_(Current ratio (local))? µ_(current ratio (Foreign)) indicating that current ratio differs by ownership type.
H_0= µ_(Cash ratio (local))= µ_(Cash ratio (Foreign)) i.e. referring to cash ratio of banks whether by local ownership or foreign ownership being the same. This is tested against the alternative H_0= µ_(Cash ratio (local))? µ_(Cash ratio (Foreign)) that cash ratios differ between the local and foreign banks.
The p-value of the independent test statistics is compared with an alpha value of 0.05 and 0.10 percent, a figure below the alpha value avoids the rejection of the null hypothesis but a value above rejects the null hypothesis for the acceptance of the alternative.
Presented in Table 4.3 and Table 4.4 below is the group statistics and the independent sample test statistics respectively. According to the findings, the mean LADT for local banks i.e. 0.61 was slightly below that of the foreign banks i.e. 0.64. Statistically, the LATD between the local banks and foreign banks are different as proven by the independent test with p-values under both the equal variance (0.409) and unequal variance (0.398) higher than an alpha value of 0.05. Thus, we reject the null hypothesis for the acceptance of the alternative hypothesis.
The Current ratio also appears slightly higher for foreign banks than for local banks. On average foreign banks have current ratio of 1.11 as compared with a mean current ratio of 1.08 for local banks. Statistically, the current ratio differs as the independent test statistics rejects the null hypothesis at both an alpha value of 0.05 and 0.10 percent for the acceptance of the alternative for the assumption of equal and unequal variances. Thus, the study establishes that the current ratio for foreign banks operating in Ghana are statically different and are better positioned than their local counterparts.
The cash ratio which is relatively higher for foreign banks than for local banks appears to be indifferent at 10 percent as the study fails in rejecting the null hypothesis for the acceptance of the alternative. The cash ratio of 0.5254 for foreign banks and 0.425 for local banks are not statistically different hence implying that banks operating in Ghana do have their ratio of cash and cash equivalents to current liabilities almost the same under a significant level of 90 percent irrespective of their ownership structure. This however, differs at higher significant level of 95 percent i.e. an alpha value of 0.05 percent. The p-values for both constant variance and non-constant variance are higher than 0.05, making the study to reject the null hypothesis.
It is evident from the above that the liquidity positions of banks operating in Ghana generally differs by ownership type with foreign banks being more liquid than the local banks. However, the ratio of cash to deposit of banks appears to be much similar at lower significant level.

Table 4.3 Group Statistics of Bank’s Liquidity Indicators
Ownership N Mean Std. Deviation Std. Error Mean
LATD Local 70 .6060 .2652 .0317
Foreign 115 .6414 .2911 .0272
CR Local 70 1.0830 .1004 .0120
Foreign 115 1.1072 .2053 .0191
CAR Local 70 .4725 .1857 .0222
Foreign 115 .5254 .2041 .0190

Table 4.4 Independent Samples Test of Bank’s Liquidity
Levene’s Test for Equality of Variances t-test for Equality of Means
F Sig. t df Sig. (2-tailed) Mean Difference Std. Error Difference 95% Confidence Interval of the Difference
Lower Upper

LATD Equal variances assumed .033 .855 -.828 183 .409 -.0354 .04270 -.1196 .0489
Equal variances not assumed -.847 156.40 .398 -.0354 .04174 -.1178 .0471

CR Equal variances assumed 10.919 .001 -.921 183 .358 -.0242 .0263 -.0760 .0277
Equal variances not assumed -1.071 176.25 .286 -.0242 .0226 -.0688 .0204

CAR Equal variances assumed .001 .972 -1.771 183 .078 -.0530 .0299 -.1120 .0061
Equal variances not assumed -1.812 156.56 .072 -.0530 .0292 -.1107 .0048

The Relationship between Liquidity and Bank Profitability
Correlation Analysis
In the first stage of the analysis, a correlation analysis is used to examine the relationship between the liquidity variables and the bank performance measures. The correlation coefficients show the extent and the direction of the linear relationship between the liquidity variables and the measures of bank performance employed. Table 4.5 below presents the results of the Pearson correlation analysis. The table also shows the correlation between the firm performance measures and the control variables.

Table 4.5 Correlation Analysis of Liquidity Ratios and Bank Performance
ROE ROA CR LATD CAR CIR SIZE
ROE/ROA 1.0000 1.0000
CR 0.0002 -0.0934 1.0000
LATD 0.1008 0.1233 0.2892 1.0000
CAR 0.0324 0.0683 0.4500 0.8824 1.0000
CIR -0.5975 -0.9194 0.1288 -0.1085 -0.0337 1.0000
SIZE 0.3531 0.5995 -0.2260 -0.1020 -0.1882 -0.5452 1.0000
All the liquidity variables have positive relationship with return on equity. This may suggest that improved liquidity situations may improve the banks’ returns on equity. Indeed, liquidity ratios represents the ability of the banks to meet their financial obligations and the higher ratio, the stronger the financial positions of the banks. However, the correlation analysis shows negative correlation between the current ratio and return on assets. Higher current ratio may suggest the failure of the banks to utilize their current assets optimally which may result into lower profits and thus, low return on assets.
(Auerbach, 2005) documents that the solvency of the firm is indicated by the current ratio since the ratio points out the number of times the firm’s current liabilities are exceeded by its current assets. But a high current ratio is not desirable either since it may connote failure to utilize available cash optimally. It is not surprising that the liquidity variables particularly, cash ratio and the ratio of liquid assets to total deposits show strong positive correlation. This is largely due to the similarity between the two ratios. Both ratios look at the banks near cash items and test the capacity of the banks to utilize their near cash items to cover their financial obligations. Again, the positive correlations between the liquidity ratios may imply that the ratios are reinforcing of each other.
Also, the correlation matrix shows that efficiency measured by cost to income ratio relates negatively with both return on equity and return on assets. Same negative relationship has been found in studies by (Almazari, 2013) and (Mathuva, 2009).
This is expected since the less efficient the bank is, the less profitable it is and consequently the lower its returns on equity and returns on asset. The findings from Table 4.5 depicts that there is a positive correlation between size and the bank performance measures. Bank size tends to have positive impact on the bank return on assets and return on equity. (Uwuigbe, et al., 2012) document similar results in their study. They explain that larger banks have relatively easier access to the capital markets and can easily obtain investable funds at lower costs and thus are more profitable relative to smaller banks.
The Effect of Liquidity on Profitability of Commercial Banks in Ghana
Regression Analysis
The study engaged a regression model to investigate the influence of liquidity management on the financial performance of banks. The regression was done using the EViews software. The study followed the fixed effects, generalized least squares and OLS panel data regression options which are mostly used in literature. The study also estimates the model using the Robust Least Squares estimations. (Yohai, 1987) explains that the sensitivity of conventional regression methods to outlier observations can result in coefficient estimates that do not accurately reflect the underlying statistical relationship. Robust Least Squares refers to a variety of regression methods designed to be robust, or less sensitive, to outliers. (Renaud & Victoria-Feser, 2010) propose the Rw squared statistic and show that the Rw squared is a better measure of fit than the R-squared. The Rn squared statistic is a robust version of a Wald test of the hypothesis that all the coefficients are equal to zero. The outputs of the robust least square panel estimations generalized least squares and fixed effects estimations are presented in Table 4.6 and Table 4.7 respectively.
The R-squared and the Rn-squared indicate that a significant variation in return on equity and return on assets is explained by the liquidity and control variables. Thus, the regression model has a considerable strong explanatory power as most of the variation in independent variables is explained by the specified regression model. The R-squared/Rn-squared results show the overall goodness-of-fit of the models used in this study. The F-statistic, Rn-squared and LR statistics also shows that the overall regression model is statistically significant and is useful in prediction purposes at 1% level of significance. Thus, the independent variables used are statistically significant in predicting the financial performances of Ghanaian banks.
The results from Table 4.6 show that liquidity ratios produce mixed effects on return on equity. Current ratios exert significant positive influences on return on equity while cash ratio has a negative and significant relationship with return on equity. Liquid assets to total deposit ratio have a positive but insignificant effect on return on equity. These mixed results are consistent with similar findings by (Owolabi, et al., 2011).

Table 4.6 Regression Results (ROE)
Dependent Variable ROE
RLS GLS Fixed Effects
Variable Coefficient
C 0.4557***
(0.1524) 0.5737
(0.5023) 0.8687
(0.5599)
Current Ratio 0.0220
(0.0510) 0.2824*
(0.1679) 0.2060
(0.1972)
LATD 0.0887
(0.0595) 0.2451
(0.1960) 0.3624
(0.2447)
Cash Ratio -0.1540*
(0.0904) -0.3695
(0.2978) -0.2533
(0.3817)
Cost Income Ratio -0.8643***
(0.0408) -1.0668***
(0.1346) -1.1062***
(0.1499)
SIZE 0.0856***
(0.0196) 0.0449
(0.0644) -0.0079
(0.0775)

R-Squared/Rw-squared 0.8552 0.4679
Rn-squared statistic 861.78
Prob (Rn-squared stat.) 0.0000
LR statistic 105.66
Prob (LR statistic) 0.0000
F-Statistic 5.5937
Prob. 0.0000

The results confirm the liquidity and profitability trade off. Holding liquid assets may reduce the risk of not meeting maturing obligations and thus increase customer confidence. Again, adequate liquidity helps to reduce financing cost which ultimately should increase profitability. However, holding liquid assets involves an opportunity cost as the bank holds assets that could otherwise be invested in high interest earning assets. This affect profitability negatively and thus the poor financial performance of banks. Indeed, (Lartey, et al., 2013), (Bourke, 1989) and (Bordeleau & Graham, 2010) find that the effect of liquidity on bank profitability is not monotonic. Liquidity affects bank profitability positively, but the effect declines at certain level of liquidity.
This study also investigates the influence of liquidity management on the return on assets of banks. The results of the regression estimates are reported in Table 4.7.
The results show that both current ratio and cash ratio have significant positive effects on bank performance measured by return on assets. This finding is consistent with (Durrah, et al., 2016) and (Al Nimer, et al., 2015).However, the ratio of liquid assets to total deposits show significant inverse relationship with return on assets, consistent with similar findings by (Eljelly, 2004). Again, these results confirm the liquidity and profitability trade off. Holding adequate liquidity means that the banks can reduce the risk of losses emanating from its attempt to sell illiquid assets to meet sudden withdrawal demands by depositors. This, however, implies that some assets are probably not invested in the available high interest earning securities. This has declining implications on bank profitability. This result provides support for (Bordeleau & Graham, 2010) who explain that the positive influence of liquidity on bank profitability declines at certain levels of liquidity. Thus, the banks must employ adequate treasury and liquidity management techniques that keeps short-term securities that can be liquidated immediately with the ultimate objective of enhancing both profitability and liquidity of the bank.
Table 4.7 Regression Results (ROA)
Dependent Variable ROA
RLS GLS Fixed Effects
Variable Coefficient
C 0.0406**
(0.0169) 0.0591***
(0.0188) 0.0511**
(0.0201)
Current Ratio 0.0263***
(0.0056) 0.0033
(0.0063) -0.0052
(0.0071)
LATD 0.0032
(0.0066) -0.0062
(0.0073) -0.0193**
(0.0088)
Cash Ratio -0.0005
(0.0100) 0.0185*
(0.0111) 0.0407***
(0.0137)
Cost Income Ratio -0.1390***
(0.0045) -0.1251***
(0.0050) -0.1243***
(0.0054)
SIZE 0.0129***
(0.0022) 0.0116***
(0.0024) 0.0139***
(0.0028)

R-Squared/Rw-squared 0.9044 0.8940
Rn-squared statistic 1727.552
Prob. (Rn-squared stat.) 0.0000
LR statistic 1144.032
Prob. (LR statistic) 0.0002
F-Statistic 53.64
Prob. 0.0000

The study results also suggest that the size of the bank has positive and significant effects on return on assets and return on equity. Larger firms have easier access to external funds and are most likely able to meet their investment needs thus increasing their profitability. Cost to income ratio which is efficiency is the measure of efficiency, has a negative and significant relationship with both return on asset and return on equity. This is quite intuitive as less efficiency should result into lower profit performance. Clearly, improving the cost efficiency of the banks has the tendency to increase the profitability of the bank.
Chapter Summary
In this chapter, the study estimates the regression model specified in equation (8). The descriptive statistics, correlation analysis and the regression results were presented in tables. The results show that the measures of liquidity do not influence the bank performance measures in the same direction. The study’s results provide evidence for the trade-off between liquidity and bank profitability. While adequate liquidity helps to reduce losses from disposing illiquid assets to meet maturing obligations, there is an opportunity cost of keeping liquid assets which declining implications on the profit performance of the banks. The control variable, size has positive and significant effects on both firm performance measures. The results also indicate that cost efficiency improves the profit performance of the banks.

CHAPTER FIVE

SUMMARY, CONCLUSION AND RECOMMENDATION
Summary
The banking system is generally seen as the backbone of financial systems. The financial system plays a central role in the economic development, fueling infrastructure development through capital provision, financing private sector development for job creation and the total development of the economy. The fundamental role of banks in the economy means that their performance is key to the health of financial system and the general growth of the economy. The recent global financial crises have raised some concerns about the liquidity management of financial institutions. Recent collapse of banks in Ghana have left lots of questions than answers. Managerial controls, regulatory challenges and financial positions of banks in the domestic market are few of such reasons observed to have contributed to the recent collapsing of banks in the country. Banks, like most business entities are expected to maximize the wealth of owners. Thus, ensuring an optimal liquidity levels which also translates into increasing profits is of great importance to the banks since the absence of liquid assets to meet both plan and unplanned customers withdrawals could cause bank runs which can affect the entire economy of a country.
The attempt to increase profit may have decreasing effects on liquidity which might affect the financial health of the bank. Low levels of liquidity can affect customer confidence and leads to reductions in bank’s patronage as well its general goodwill. Inadequate liquidity can also affect negatively, the bank’s credit standings and in the worst scenario might result in forced asset liquidation. However, the maintenance of liquid assets to meet maturing obligations and sudden customer demands has declining implications for bank profitability. Thus, this research investigates the effects of liquidity management on the financial performance of banks. With a sample of 21 Ghanaian banks. The performance measures employed were return on assets and return on equity and the liquidity ratios used include current ratio, cash ratio and the ratio of liquid assets to total deposits. The influences of liquidity ratios on the performance of the banks in Ghana was assessed and analysed using descriptive statistics, correlation analysis and panel regression models.
Conclusions
Descriptive statistics revealed that the liquidity variables showed significant variations perhaps due to the variations in structures of the banks. Within the period, 2007–2015, the banks recorded on the average 1.1 Cedis in liquid assets to pay for every 1 Cedi in current liability and 63 pesewas in liquid assets to pay for every 1 Cedi of deposit. Apart from the current ratio, the other liquidity measures recorded an average of less than one (1) over the study period. This may imply that the banks were not able to fully cover their short-term financial obligations. The low liquidity positions of the banks may not augur well for the confidence of the customers and might result into low patronage of banking services.
The descriptive statistics also shows that, Ghanaian banks generally maintained stable ratios over the period, witnessing very little fluctuations. The foreign banks generally recorded higher liquidity than the local banks, indicating that foreign banks may rely less on deposit financing. The relative financial strength of the foreign banks may suggest that foreign ownership of banks may help to improve the overall strength of the financial system.
The correlation analysis shows that the liquidity measures have mixed relationship with the performance measures. This is explained by the fact that while high liquidity ratios indicate the financial strength of the banks (and can potentially boost confidence and increase its goodwill), a higher liquidity ratio is not desirable either, since it may connote failure to utilize available cash optimally. Also, the correlation analysis shows that the liquidity variables are positively correlated. This may imply that the liquidity measures are strengthening of each other.
Results of the regression analysis show that the liquidity ratios produce mixed effects on the performance measures. This finding confirms the liquidity and profitability trade off. Holding liquid assets may reduce the risk of not meeting maturing obligations and thus increase customer confidence. Again, adequate liquidity helps to reduce losses from the need to dispose illiquid asset to meet customer demands which ultimately should increase profitability. However, holding liquid assets involves an opportunity cost as the bank holds assets that could otherwise be invested in high interest earning securities. This affect profitability negatively and thus the poor financial performance of banks. Thus, the need to continuously assess the liquidity situations and adopt positions that do not jeopardize the financial strength of the banks but also enhances profit. Also, the study results revealed that, bank size increases with bank performance while cost efficiency improve the profit performance of the bank since they have a significant negative relationship with profitability.
Recommendations
Based on the results from this study, the following recommendations are made:
The findings of this study indicate significant relationship between liquidity and bank profitability. This calls for adequate treasury and liquidity management. Thus, employees should be trained sufficiently in the areas of treasury and liquidity management. It is important that issues of liquidity are considered as key business decisions and treated with utmost importance. It is crucial that the liquidity position of the bank is carefully monitored, and any changing condition is assessed and addressed promptly.
The study finds support for the liquidity and bank profitability trade off hypothesis. Thus, it is crucial that the liquidity management system of the bank involves the adoption of optimum system which sets out to address possible risk of liquidity gaps and increase profits and returns on investment. This should help to enhance the survival and sustainability of the banks and improve the stability, development and growth of the financial system. It is important to obtain detailed understanding of the liquidity stand of the bank across all counterparties, business lines, accounts and currencies to optimize liquidity balances. The setting of minimum liquidity levels enables bank managers to minimize the risk of liquidity gap and maintain enough liquidity to cover maturing obligations and everyday operating expenses.
The results of this study show that the liquidity measures have mixed effect on bank profitability. This may imply that the liquidity needs of the bank depends largely on the product mix, structure of the balance sheet and cash flow profiles. Thus, the framework of liquidity analysis should involve managers identifying key business drivers. This can inform the approach towards liquidity management to eschew liquidity gaps and increase bank profitability. It is recommended that high quality liquid assets are maintained as a buffer to hedge against sudden liquidity outflows.
Efficient regulatory environment is crucial for efficient management of liquidity risk. There is the need to ensure constant review of prudential guidelines to help with the efficient management of liquidity within the financial industry. This is important given that operating and financial risks such as legal, interest rate, and credit risks can have greater effects on the liquidity profile of a bank. Also, the availability of liquid and easily transferable financial assets is a key determinant of the bank’s capacity to provide liquidity. Thus, there is need to improve liquidity and asset transferability within the financial system. While the assets must be easily convertible to cash or near cash at short notice, ownership rights in them should be very portable across economic agents and in forms that are generally acceptable.
There is the need to also ensure stability on the macroeconomic front since external events within the macro economy can influence the liquidity profile of an institution. Activities within the economy can influence the bank’s liquidity holdings. Demand for credit facilities as economic activities uptick, hence possible rises in profits and liquidity from the improved lending activities. Thus, banks’ liquidity holdings are influenced by macroeconomic indicators such as aggregate economic activities, inflation and interest rates. Stability on the macroeconomic environment is therefore necessary in the management of liquidity risks.
The study finds that cost efficiency is critical in improving the profitability of banks. Managers should therefore focus on operational efficiency to improve their profits. Also, there is the need to be forward looking, and adopt efficient practices and technologies in the ever-changing banking environment to remain competitive and efficient and maintain their goodwill in the face of liquidity crises and increasingly competitive industry.