Abstract
The recent financial crisis has highlighted the significance of sound liquidity management. Liquidity risk is one of the key issue for financial institutions. An organization with a strong asset base, adequate capital and earning may fail if not sustained good liquidity positions. This study attempts to empirically examine the impact of liquidity risk on the performance of selected banks operating in Pakistan. The panel data over a period of 2006-2015 was collected from the yearly published financial statements of banks working in Pakistan. The data was examined through the panel data regression model. Bank size, nonperforming loan ratio and capital adequacy ratio were used as surrogate variable for liquidity risk. The profitability of the selected banks was measured by taking the ratio of return on assets. The results of the regression model show a major impact of liquidity risk on the performance of Banking Institutions. The influence of the capital adequacy ratio and bank size was found significant and positive, while the influence of the nonperforming loan ratio proved insignificant. This study helps to understand the important parameters of liquidity risk and their influence on bank profitability. This study is valuable for risk managers to alleviate liquidity risk by having satisfactory liquid assets. This minimizes the liquidity gap and dependency of the financial institutions on the repo market.
Highlights
The 2007-08 worst global financial downturn after the Great Depression of the 1930s drag down the world financial system
The results of the analysis are consistent with previous studies (Demirgüç-Kunt & Huizinga, 1999; Gizaw, et al, 2015; Gul, Irshad, & Zaman, 2011; Kosmidou, et al, 2006; Naceur, 2003; Valverde & Fernández, 2007). It is concluded based on the analysis that bank assets size (BS) and capital adequacy ratio (CAR) have a significant and positive impact on the performance of the selected banks working in Pakistan
The effect of the nonperforming loan ratio was observed detrimental and insignificant, which implies that higher rate of non-performing loans contributes to reduce theprofitability of the banks
Summary
The 2007-08 worst global financial downturn after the Great Depression of the 1930s drag down the world financial system. Most of the financial institutions were exposed to lack the forecasting models for the effective management of liquidity risks. These insufficiencies lead to liquidity crisis and the deterioration of the balance sheet as well as the problems of finding new sources of funds (Cucinelli, 2013). As stated by Jenkinson (2008), the worldwide financial devastation of 2007-08 emphasized that liquidity risk has a momentous impact on the viability of the financial institutions. Banking institutions perform an extensive activity that exposed them to financial risk. Liquidity issues affect bank’s reserve and capital as well as breakdowns the whole banking system. The less advantaged operational and financial activities of financial institutions affect economic growth and disrupt the entire structure of a country's economy. The good performance of financial institutions means prosperity and economic growth (Khan & Ssnhadji, 2001)
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