Abstract
The relationship between liquidity and bank performance in finance literature remains an unresolved empirical issue. The main objective of this article was to investigate the relationship between liquidity mismatch index (LMI) initially developed by Brunnermeier, Gorton and Krishnamurthy (2012) and further developed by Bai, Krishnamurthy, and Weymuller (2018) and South African bank performance empirically. Different from other prior studies, the study undertook to determine the relationship employing the liquidity measure that integrates both market liquidity and funding liquidity within a context of asset liability mismatches. The unit of analysis was a panel of 12 South African banks over the period 2008–2018. Specifically, two liquidity measures – the bank liquidity mismatch index (BLMI) and the aggregate liquidity mismatch index (ALMI) were regressed against bank performance matrices. The newly developed liquidity measures are based on portfolio management theory and they account for the significance of liquidity spirals. Results revealed that, bank performance is negatively and significantly related with BLMI. While the bank performance is positively related to ALMI, the relationship is not significant. Also, the nature of relationship is dependent on the measure of profitability employed.
Highlights
Liquidity is the centrepiece in the performance of banks
The results of this study reveal a significant impact of bank liquidity mismatch index (BLMI) on performance as measured by return on assets (ROA), return on equity (ROE) and net interest income (NIM)
The results showed that bank profitability (ROA and NIM) is negatively affected by an increase in Non-performing loans (NPL)
Summary
Liquidity is the centrepiece in the performance of banks. In the theoretical model by Diamond and Dybvig (1983), banks performance is primarily derived from the difference between the returns from illiquid bank assets and the cost of liquid bank liabilities. Bank liquidity should be analysed from the asset standpoint and liability view point. Brunnermeier, Gorton and Krishnamurthy (2012) argue that liquidity should be viewed from the perspective of the overall banking system which comprise of the bank assets, bank liabilities and the liquidity of the general market. The modified liquidity measures were regressed against the bank performance measures including, return on assets (ROA), net interest income (NIM) and return on equity (ROE).
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