The Effect Of Liquidity Management On The Profitability Of Deposit Taking Financial Institutions In Kenya

Abstract

Robustness of the financial system is indispensable in ensuring the economic growth and stability of any given country. Liquidity risk management is one of the key aspects that influence, not only the profitability of a financial institution, but also its sustainability and reputation. The purpose of this study was to explore the effect of liquidity management ratios on the profitability of deposit taking financial institutions in Kenya. Specific objectives of the study were to assess the effect of current ratio, liquid ratio, loans to deposit ratio and loans to asset ratio on profitability of deposit taking financial institutions in Kenya. Additionally, the study evaluated the moderating role of management efficiency on the relationship between liquidity and profitability of deposit taking financial institutions in Kenya. The study applied a descriptive research design and targeting 38 commercial banks and 6 DTMs, all with data spanning five years between 2012 and 2016. Secondary data utilized in this study was collected from the published financial statements of these institutions. The study employed panel regression analysis model using Stata statistical software. The data analysis process entailed exploratory analysis, pre-test diagnostics, fitting of the model and post-test diagnostics. The outcome of the analysis has been presented in tables and figures and interpreted appropriately.Study findings indicated that current ratio did not have a significant effect oneither ROA (β = -0.6748; p > 0.05), ROE (β = -1.8589; p > 0.05) or NIM (β = -0.3881; p > 0.05). Liquid ratio had a significant positive effect on both ROA (β = 6.6098; p < 0.05) and NIM (β = 2.6504; p < 0.05)but had no significant effect on ROE (β = -5.9980; p > 0.05). Further, loans to deposit ratio had no significant effect on neither ROA(β = -0.0782; p > 0.05), ROE (β = -0.0017; p > 0.05) nor NIM(β = -0.0513; p > 0.05).Additionally, loans to assets ratio had no significant effect on ROA (β = -0.3262; p > 0.05) but had a negative and significant effect on ROE (β = -4.8505; p < 0.05) and a positive and significant effect on NIM(β = 0.0004; p < 0.05). The study recommends that financial institutions should ensure that they maintain a liquidity ratio that is enough to comply with CBK regulations and at the same time ensuring an optimum liquidity level to minimize the institution’s liquidity risks. The institution’s past liquidity ratio levels and the institution’s performance and risk indicators should be analyzed and this evidence used in arriving at the optimum liquidity levels that are best suited for the context of the institution.