The Impact of Liquidity on Profitability of Commercial Banks: A Study conducted on selected Private Commercial Banks in Ethiopia.

Abstract

The concept for Liquidity has been frequently used by financial institutions including the National Banks of many countries and researchers. Furthermore, as the optimum level of liquidity has a vital contribution towards development of economy, the opposite also leads to incidence of huge loss on banks in particular and country in general. Hence this study is conducted to examine the impact of liquidity on profitability of selected private commercial banks in Ethiopia. This research is explanatory research, which identifies the cause and effect relationships between the variables found in secondary data. The explanatory variables in this study are Deposit to Asset Ratio, Loan to Deposit ratio, Cash to Deposit ratio, Other Investment ratio, operational Expenses and Bank size which all measure liquidity while Return on Asset is the explained Variable. To this end, the researcher has selected seven senior private commercial banks in Ethiopia judgmentally. The study used panel data over the period 2005-2019 and secondary data was collected from National Bank of Ethiopia and selected private commercial Banks. The analysis was made using secondary panel data collected from national bank supervision department for seven banks as representatives. The study was made using STATA version 14 software. The fixed effect model was used for the analysis. The result shows that among explanatory variables included in the study Loan to Deposit ratio, Deposit to Asset ratio, Operational expense ratio and Banks size have been found significant at 5% significance level. Among the statistically significant factors affecting banks profitability, Deposit to Asset ratio and Bank size has had a positive impact on profitability of private commercial banks whereas Loan to Deposit ratio & Operational expense ratio has had negative effect on profitability of Private Commercial Banks. The finding of this study is significant since once the impacts of Liquidity on ROA have been known; it might enable to make appropriate decisions to balance the amount of liquidity to prevent the occurrence of loss due to liquidity risk in the future. Thus; it is better for NBE and PCBs to put a clear policy framework that would addresses the issues of conflict of interest for those involved in decision making process.