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The Effect Of Liquidity On The Profitability Of Commercial Banks In Nigeria

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Study Level: BTech, BSc, BEng, BA, HND, ND or NCE

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The Effect Of Liquidity On The Profitability Of Commercial Banks In Nigeria




The history of banking business in Nigeria dated to the colonial Era  with  the  Establishment of first commercial bank.


         Opened its  first branch in 1892, Messis Dempster and co a shipping firm based in Liverpool  actively  involve in trading in Nigeria organized a trust  and registered in Liverpool with monetary banking from the British colonial  Government. The  sole responsibility  of  African  banking corporation  was the distributors of  bank of  England’s  note for the British to treasury.

          The Bank experienced some difficulties at initial and Eventually  decide  to transfer  its  interest  to Elder  Dempster in1893.

          This  led  to  the  formation  of  a  bank   known  as BRITISH BANK OF WEST AFRICAN (BBWA)  in 1893  with $10,000 capital which was  later Increase to $100,000 during  the same year. The first Lagos  branch  was opened  in the  year 1891. While the  second  Nigeria  branch  was  opened in old  Calabar  in 1900.

During  this period  the British Bank  of  West Africa  (1894)now FIRST BANK OF NIGERIA PLC  and  Barclay  DCO(Dominion  colonial and overseas 1917)  now UNION BANK OF NIGERIA PLC  which  enjoy a virtual monopoly of  banking  industry.

Before 1894,  Nigeria  have  become used to cowries and manila  as unit of monetary  transaction. This means that the banking system did not come to Nigeria in 1894  as  a fresh experience.

       This is supported by  the fact that  they had their  small trust groups  and kept money  in safe places. The ideal of cowries and manila was  introduced by  the merchant of  the Royal Niger Company, the antecedent of  the present  U.A.C to standardize  coinage system  when the British  Bank  Of  West Africa  (BBWA)  was established, people were very suspicious of  its intention.

However,  such  men  asking Jaja  of  Opobo,  Taiwo   Olowo, Da_Rocha  and many others to  named after  where largely  used in getting  the message across  to the people  (Akinosho 1984 p.7).

The Bank Of  West Africa  (BBWA)  later  changed  to BANK OF  WEST AFRICA  (BWA)  in 1956  owing to ownership structure of  the present Company  (Standard Chartered Bank plc in UK)  it again change its  name to  STANDARD BANK OF NIGERIA  in 1979  the  following  Nigerian  acquisition of  majority shares,  it become FIRST BANK OF NIGERIA (FBN) BARCLAY BANK  (DCO)  joined in 1916 and opened it branch in Lagos in 1917. Barclay Bank  DCO  was renamed  UNION BANK OF NIGERIA (UBN) after 80%  of  Nigeria  share,  soon after nine (9) other branch’s were opened.

        The foreign banks came principally  to render services in connection with international  trade. So  there relations at  that time were  chiefly  with the  expatriate  trading  companies and with the government. They largely ignored the development of local  Africa  entrepreneurship.  Together  these  three (3) banks controlled  closely  to 90%  aggregate  bank  deposits  from 1894  to the early 1930.  several abortive attempts were made to established locally owned  and managed banks to break foreign monopoly.

        In 1945, the private  indigenous bank  to be established was the  AGBOMAGBE BANK founded by chief  Okupe. The bank was taken by the western  state government  in 1969 and its name was changed to WEMA BANK PLC.

         The  merchant  bank  was  opened  for  the  business  in 1952  and crashed  in  1960.  Another   successful  indigenous bank  was  the AFRICA CONTINENTAL PLC (ACB)  founder by Dr  Nnmadi Azikwe in 1947  (ACB plc is currently having mismanagement problem).  Between 1947 and 1952,  this was a free for all banking, a total of twenty  two (22) banks were registered in  Nigeria.  (CBN conducted study)  professor Grein  O. Nwankwo. (1980)  reported  that the country  witnessed the registration of 185 banks.

In 1947 only, 145 banks were registered and in 1952. This period  can be  describe  as the first  phase  which  was characterized by the absence  of any  banking  legislation to control the activities of this banks. 

The rare of bank failure that time prompted the Government to set up the patrol commission of injury in1948 to investigate the banking condition in the country and tostipulate  the condition for healthy banking  industry operations. It was discovered that the  liquidation of most of these bank was due to gross mismanagement.


The role of commercial banks as saving institution and as financial Intermediaries  enable the commercial banks to perform an important Services to all  sector of economy by providing facility  for the mobilization of savings and making the form available for investment  purposes by process of granting  credit facility to other  customer. According Reedetal (1984), the primary function of  commercial banks  convert shot term  deposit  into long term loan and  revolve it to generate income for themselves.

They bring together people who have to save  (which they will like

to lend out, but who also need the assurance or guarantee that they can have the money back wherever they wish) and those who need money (to borrow now and pay back later).

The act as intermediaries, collecting deposits and payment interest on them  and making  loans  and  changing  the  borrower  interest  at higher rate. However, there  in legal  limit  to credit  creation of  banks. Credit  creation and consequent  profitability is  restricted by central bank control.


At the micro_level the individual commercial bank is viewed as an economic unit  whose  goal is to maximize profit.  Banks hold portfolio of  asset and given the characteristic and distribution of their liabilities, they attempt to structure their portfolio of asset in such manner as to  yield the greater return.

The asset are two groups of balance sheet  items called loan and investments,

Profit are generated by  earning  assets  (loan and investments)  while is provided partly  by earning  assets  like short_terinvestment  and  partly  by non_earning  assets  e.g.  cash  balance  held  in the bank vault  and also  at the central bank, called money reserves. e.t.c.


The project will analyze the problem faced by the commercial banks in maintaining  equilibrium between profitability and liquidity some of the belong  faced by the commercial banks in maintaining  equilibrium between profitability and liquidity arise from;

Like other comprises bank also incurred substantial  cost and must be earn an  income at least  sufficient  to meet there cost. They also accountable to their shareholders who have invested in them with the aim of good return interim of future dividends. From these point of view banks need assets which produce income substantially higher  than that paid on deposits.

         In practice, these two objectives (profitability and liquidity) tend to work in opposite directions. Cash itself produce no income and the relatively liquid assets like money, treasury bills and treasury certificate usually produce low income. The rivalry between liquidity and profitability remains a headache to the management of banks. But for the need to harmonically balance  profit  motive and maintenance adequate  liquidity, most banks would certainly overemphasize the pursuit of the profitability at the determinant of  remaining  liquid can have disastrous consequence. The  precisely way in which this harmonious  balancing is  aid rived in  Nigeria will be examine in details in the chapter two of this project.

1.3            PURPOSE OF STUDY

This project aim at bringing out the effect of the regulatory power given  in the CBN decree 24 of 1991 and BOFID decree 25 of 1991. This project will analyze the effect of liquidity on profitability of commercial banks in Nigeria so as to determine whether the control is effective.  The purpose of economy in general will be covered in this project. The purpose of this liquidity control by the CBN will be examined, so that it may be conducted whether the control is really achieving objectives or not.  The project  will make  suggestion on how  to solve the problem of balancing  liquidity and profitability dilemma. The problem of optimal assets selection to yields maximum profits will also be analyze in this project.

1.4a         SCOPE OF THE STUDY

The Control weapon of the CBN liquidity ratio affects

the profitability of  all banks and other financial institution  but this project will be limited  only the affect of  liquidity on profitability of commercial banks in  Nigeria,  because this weapon of central bank usually affect the commercial banks more than the other financial institutions. This study is a theoretical  exposition which focuses attention on the central problems of  bank management  reconciling  the conflicting  banks goals of profit ability, liquidity and solvency which in all affect the operation of the banks.


        Finance is the main constraints facing this research work coupled with short available of  time. The research is  self sponsored and so  could  not  afford the cost of elaborate area of courage.

         Another major limitation is the difficulties in obtaining material information as there  are reluctances  from sources.


Working on the premise that the day of cheap profit

are gradually been eclipsed and that in future, banks would need to complete more fiercely for business only those bank can show innovative approaches to treasury and fund management will be capable of surviving the competition ahead. Although the Nigeria scare as remind up till now a seller’s strong balance sheets huge profit and impressive dividedness, this trend in unlikely to continue much longer, hence, it has now become expedient for banks to appraised their  asset mix policy,  goals  and procedures, so that they are not change by the time unless new and portfolio management strategies are brought into places bank might in future be left.

         Apart from the foregoing considerations, the present treasury and management techniques used in Nigerian banks are often time based on haphazard and subjective factors which tends to increase the risk of goal achievement.

The generally accepted of techniques of quantitative and scientific techniques are very rarely used in publication by Adekanye Femi (1986) he noted that up fill now, there is no report of the techniques and management science/ operation research techniques in banking were as considerable integration of these technique for banking decision have been evolve in America, Europe and Japan.

The main focus of this project is therefore to develop a decision model in asset mix (Treasury and fund  management) for the policy making and senior management in commercial banks using linear programming model. The model we hopefully assist banks in enhancing their profitability effectively from it present low point, this improve target planning and achievement.


Liquidity: Bank liquidity is the ability of a bank to be in a position to meet the demand of depositors and borrowers virtually all economic unit needs liquidity.

Profitability:It can be considered as the main motive of banks as it maximization ensures the survival and growth of economic unit.

Solvency: It’s often used as a synonym for liquidity. It is the ability of banks to meet its day of obligation or activities to the deposition and credit customers, solvency is the ability of a bank to meet its long term obligation.

Portfolio: There are the lists of security and investment (stocks, shares) owned by a bank.

Demand deposit:These are the money saved by customers of a bank subject to recollection on demand.

Monopoly:       this is the existence of one or few economic unit in a particular industry thereby enhancing the few economic units to have uncompetitive control over the industry.

Expatriate banks: Theseare foreign owned banking institutions.

Indigenous bankThese are locally owned banking institutions.