Executive
Summary
This research identifies and examines
the potential causes of liquidity risk of 10 private commercial banks in Bangladesh
and evaluates their effect on banks’ Loan to Deposit. The research displays an
empirical relationship between factors of liquidity risk and their effect on Loan
to Deposit of the banking sector.
Data is collected from the income statements, balance sheet of 10 private
commercial banks in Bangladesh during 2007-2016. Multiple regressions are
applied on data in order to evaluate the impact of liquidity risk on banks’ Loan
to Deposit. The results of multiple regressions show that banks’ Loan to Deposit
is affected by liquidity risk significantly. Economic factors supporting
liquidity risk are not covered in this study. This study addresses the problem
of liquidity risk faced by the banking sector in Bangladesh.
The study helps in understanding certain aspects of liquidity risk and their effect on Loan to Deposit of the banking industry. Liquidity is a bank’s capacity to fund increase in assets and meet both expected and unexpected cash and collateral obligations at reasonable cost and without incurring unacceptable losses. In the context of banking, liquidity, or the ability to fund increases in assets and meet obligations as they come due, is critical to the ongoing viability of the banking institution. Since there is a close association between liquidity and solvency of banks, sound liquidity management reduces the probability of banks becoming insolvent, thus reducing the possibilities of bankruptcies and bank runs.
The study helps in understanding certain aspects of liquidity risk and their effect on Loan to Deposit of the banking industry. Liquidity is a bank’s capacity to fund increase in assets and meet both expected and unexpected cash and collateral obligations at reasonable cost and without incurring unacceptable losses. In the context of banking, liquidity, or the ability to fund increases in assets and meet obligations as they come due, is critical to the ongoing viability of the banking institution. Since there is a close association between liquidity and solvency of banks, sound liquidity management reduces the probability of banks becoming insolvent, thus reducing the possibilities of bankruptcies and bank runs.
1. Introduction
1.1 Background of the Study
Banks are the
principal part of the financial segment in any economy, which perform valued
activities on both edges of the statement of affair / balance sheet. On the
Liability end, they provide liquidity to account holders i.e., investors, whereas
they augment the flow of funds by advancing to the cash-starving customers of
funds (Halling & Hayden, 2006) . The strength of the
banking system is integral to the economic immovability and growth (Diamond & W.Rajan, 2001)
Financial
institutions also facilitate the settlement and payments systems and support
the smooth transmission of goods and services. They certify prolific investment
of capital to motivate the economic growth. They help in the growth of new
businesses, thereby increasing the employment and enabling the development.
Lately, liquidity risk has attracted regulators, researchers and banks
following a number of economic and banking crises across the globe. The
regulators and banks are now considering the liquidity situation of banks.
The bank may
lose the confidence of its accountholders if funds are not provided to them
well in time. Consequently, the regulator may also impose penalties on the banks.
Therefore, it is necessary for banks to manage and keep comprehensive liquidity
at every stage to safeguard the risk. Liquidity risk has been a serious cause
of anxiety and challenge for banks lately. Liquidity risk affects the
performance and reputation of a bank (Jenkinson, 2008) . Even a bank which has upright asset
quality, adequate capital and robust earnings may fail if it is not upholding
acceptable liquidity (Crowe, 2009) . Extraordinary
competition for customer deposits, a wide collection of funding products in
corporate and capital markets with technological improvements have changed the
finance structure and risk management arrangement.
There are many
risks tackled by banks such as market risk, credit risk, interest rate risk and
operational risk which may appear in the form of liquidity risk (Brunnermeier
& Yogo, 2009) .
Banks should be prepared to deal with the fluctuating monetary policy that
figures the overall liquidity trends and its own transactional requirements and
settlement of short term borrowing.
1.2 Research Objectives
This research
investigates the liquidity risk in Bangladeshi banks and evaluates the effects
on bank's Advance to Loan. The main objective of this research is to identify
the problems facing the banks during the period 2007-2016 under liquidity risk
category.
The study aims
to accomplish this important objectives:
·
To
identify the determinants of liquidity.
·
To
evaluate current situation of banking sector in Bangladesh
·
To
analyze the numerical data of the selected banks by using statistical measures.
1.3 Limitations
·
Only
focused a 10 Private Commercial banking
sector have been focused. Future research can be carried out by taking a larger
sample.
·
The
obtained data is for a short period of 10 years i.e. 2007-2016.
·
Economic
factors creating liquidity problems have not been taken into account. The
future researchers can also take in consideration these factors while studying
liquidity risk.
·
No
comparison has been made between the different types of banks. Future
researchers can also undertake comparative study e.g. public and private banks,
national and international banks etc.
·
The
study does not include other measure of performance except earning of bank.
Future researchers can also take in consideration the financial as well as non financial measures of performance.
2. Literature Review
Steven J. L and
B.D Roderick (1992), and Graham. H, (1993), suggested that as the loans to
deposit ratio rises and hence liquidity falls, banks would be reluctant to lend
that leads to higher loan rates. Again, banks in a liquid situation as
indicated by low loans-deposit ratio or recent inflows of deposit would tend to
offer lower loan rates compared to banks in a less liquid situation.
Slovin and
Sushka (1984) also found evidence that banks with rapid growth in deposit and
hence higher liquidity set lower loan rates. Thus, given the relationship
between liquidity and loan rates, the relationship between bank liquidity and loans-deposit
ratio would depend on the interest rate elasticity of demand for loans.
Bourke (1989)
used the ratio of liquid assets to total assets as a measure of liquidity. The
higher the ratio, the higher the liquidity and vice-versa. Bourke’s results
indicated a significant positive relationship between liquidity and loans-deposit
ratio.
Literature on
the topic of bank liquidity determinants offers a limited range of studies that
empirically validate the influence of internal, bank specific and external,
macroeconomic factors over the liquidity of banks. In 2006, an analysis over a
panel of English banks (Valla, Saes-Escorbiac, 2006) reported a determinant
negative correlation with liquidity of the GDP real growth and also, of the net
interest margin, seen as an opportunity cost for holding liquid assets. In the
banking system of the emerging economies (Bunda, Desquilbet, 2008), the capital
adequacy measure is validated as a positive influence over the liquidity and
the inflation rate, which increases banks' vulnerability to nominal values of
loans, is directly related to liquidity. Furthermore, a study over a panel of
European banks (Lucchetta, 2007) confirms that the more liquid the bank is, the
more it lends in the interbank market. Also, the study shows that the interbank
interest rate will be an incentive for holding liquid assets. At the same time,
assuming a lower credit risk (measured as a ratio between loan loss provisions
and net interest revenue) will ensure a higher level of liquidity. In 2009, the
liquidity of the state-owned savings banks in Germany has been validated to be
negatively related to the monetary policy interest rate and the level of
unemployment rate (Rauch et. al). Also, the level of liquidity in previous
period has been directly determinant for the analyzed liquidity.
Banks today are
under great pressure to perform- to meet the objectives of their stockholders,
employees, depositors and borrowing customers, while somehow keeping government
regulators satisfied that the bank’s policies, loans and investments are sound
Rose (2004). Commercial banks are profit seeking organizations. Banks have to
earn profits because if they don’t, all the shareholders would sell off the
shares if proper dividends are not earned. Hence they have to earn profits for
their shareholders and at the same time maintain liquidity to satisfy the
withdrawal needs of its customers. Bank liquidity management involves a
tradeoff between the cost of attaining higher liquidity and the cost of
inefficient allocation of such liquidity. Bourke (1989) finds some evidence of
a positive relationship between liquid assets and bank profitability for 90
banks in Europe, North America and Australia from 1972-1981.
Earlier, many
scholars have been converging on liquidity risk originating from the balance
sheet liability side of a bank. Concurrently, less consideration has been given
to the possibilities arising from the asset side. Liquidity risk may rise due
to the failure or delays in cash flows from the debtors or early end of the
missions (Diamond & Rajan, 2005). A Spartan liquidity disaster may cause
enormous drowning in form of insolvencies and bank runs (Goodhart, 2008),
leading to a radical monetary crisis (Mishkin et al., 2006).
Apart from the
above-mentioned maturity disparity, liquidity risk also arises due to
deteriorating economic circumstances; causing less reserve cohort and alarm the
savers. This may show the disappointment of a bank, in fact the entire banking
system due to Poisson effect (Diamond & Rajan, 2005).
There are two
basic aspects of liquidity risk (Good hart, 2008), maturity renovation i.e.,
the bank’s assets and liabilities’ maturit; and essential liquidity of a bank’s
asset that is the level of assets which can be sold out without experiencing a
significant loss under any market situation. These elements of a bank’s
liquidity are entangled. Banks do not required to be concerned about the
maturity renovation if they have the assets that can be traded without bearing
any loss.
Banks and
Institutions face liquidity risk if they are not discharging their assets at a
realistic price. The price enticing remains risky due to drained sales
circumstances, while liquidating any of the institute’s assets immediately.
This may result in a substantial drop in earnings. Extensive withdrawal of
deposits may also generate a liquidity deception for Financial Institution
(Jeanne & Svensson, 2007: Kumar, 2008), however, this may not be always the
main source of liquidity risk (Holmstrom & Tirole, 2000: Diamond &
Rajan, 2005). There are numerous other aspects of creating gigantic liquidity
complications for the banks. For instance, the widespread commitment and
long-standing lending may severe liquidity issues (Kashyap et al., 2002).
Furthermore, banks having a huge coverage in long-term advances may face
difficulties in liquidating due to high liquidity pressure.
Overview of the Banking Sector in Bangladesh
3. Banking Sector in Bangladesh
There are 57 scheduled banks in Bangladesh
who operate under full control and supervision of Bangladesh Bank which is
empowered to do so through Bangladesh Bank Order, 1972 and Bank Company Act,
1991. Scheduled Banks are classified into following types:
Banking sector
in Bangladesh comprises of State Owned Commercial Banks (SCBs),
government-owned Development Financial Institutions (DFIs) or Specialized Banks
(SBs) dealing with development finance, Private Commercial Banks (PCBs) and Foreign
Commercial Banks (FCBs)
Currently, there
are 4 SCBs, 2 DFIs, 40 PCBs and 9 FCBs in Bangladesh. The following Table shows
the current (December, 2017) banking structure in Bangladesh.
Banks Types
Name
|
Number of
Banks
|
State
Owned Commercial Banks(SCBs)
|
4
|
Development
Financial Institutions(DFIs)
|
2
|
Specialized
Banks (SBs)
|
2
|
Private
Commercial Banks (PCBs)
|
40
|
Foreign
Commercial Banks (FCBs)
|
9
|
Total
|
57
|
There are now 6
non-scheduled banks in Bangladesh which are:
- Ansar
VDP Unnayan Bank,
- Karmashangosthan
Bank,
- Grameen
Bank,
- Jubilee
Bank,
- Probashi
Kollyan Bank,
- Palli
Sanchay Bank
3.1 Banking System in Bangladesh
The Banking Industry is Bangladesh is one characterized by strict
regulations and monitoring from the central governing body, the Bangladesh
Bank. The chief concern is that currently there are far too many banks for the
market to sustain. As a result, the market will only accommodate only those
banks that can transpire as the most competitive and profitable ones in the
future.
Currently, the major financial institutions under the banking
system include:
- Bangladesh
Bank
- Commercial
Banks
- Islamic
Banks
- Leasing
Companies
- Finance
Companies
Of these, there are four nationalized commercial banks (NCB), 5
specialized banks, 11 foreign banks, 26 domestic private banks and 4 Islamic
Banks currently operating in Bangladesh.
3.2 Conceptual Framework
The liquidity
risk of banks arises from funding of long-term assets by short-term
liabilities, thereby making the liabilities subject to rollover or refinancing
risk. Liquidity risk is usually of an individual nature, but in certain
situations may compromise the liquidity of the financial system. As in overall
terms it is about a situation that is very dependent on the individual characteristics
of each financial institution, defining the liquidity policy is the primary responsibility
of each bank, in terms of the way it operates and its specialization. Bank Deposits
generally have a much shorter contractual maturity than loans and liquidity management
needs to provide a cushion to cover anticipated deposit withdrawals. Liquidity
is the ability to efficiently accommodate deposit as also reduction in
liabilities and to fund the loan growth and possible funding of the off-balance
sheet claims. The cash flows are placed in different time buckets based on
future likely behavior of assets, liabilities and off-balance sheet items. The
liquidity risk is closely linked to other dimensions of the financial structure
of the financial institution, like the interest rate and market risks, its profitability,
and solvency, for example. The interest rate risk that results from mismatches
of maturities or the dates for interest rate adjustments may appear as either
market or refinancing (and/or reinvestment) risk. Also, as it operates to
transform maturities, subject to these risks, the bank collects a yield that is
related to its profitability. Having a larger amount of liquid assets or
improving the matching of asset and liability flows reduces the liquidity risk,
but also its profitability. This relationship also operates in the opposite
direction: loans in an irregular situation will impact jointly on profitability
and liquidity, as the expected cash flows do not appear. In addition, there is
a relationship with solvency: more capital reduces liquidity creation, but
allows for more strength to face financial crises.
Liquidity risk
can be sub-divided into funding liquidity risk and asset liquidity risk. Asset liquidity
risk designates the exposure to loss consequent upon being unable to effect a transaction
at current market prices due to either relative position size or a temporary
drying up of markets. Having to sell in such circumstances can result in
significant losses. Funding liquidity risk designates the exposure to loss if
an institution is unable to meet its cash needs. This can create various
problems, such as failure to meet margin calls or capital withdrawal requests,
comply with collateral requirements or achieve rollover of debt. These problems
may force an institution to liquidate assets; in such a case, asset liquidity
and funding liquidity risks may combine if the institution is forced to sell
illiquid assets at fire-sale prices. In such a situation, if portfolio leverage
is high, the forced selling may create a positive feedback loop between falling
prices (resulting in margin calls) and additional rounds of forced selling. Liquidity
risk is managed through controlling concentrations and relative market sizes of
portfolios in the case of asset liquidity risk, and through diversification,
securing credit lines or other back-up funding, and limiting cash flow gaps in
the case of funding liquidity risk.
3.3 Liquidity Risk
Banking
parlance, liquidity is a financial institution's capacity to meet its
obligations as they fall due without incurring losses and liquidity risk is the
risk to an institution's earnings, capital & reputation arising from its
inability (real or perceived) to meet its contractual obligations in a timely
manner without incurring unacceptable losses when they come due.
Breaking this
further down we get mismatch risk (due to ineffective match between cash
inflows and outflows obligations cannot be met in normal course of business
following sufficient cash shortage), market liquidity risk (when bank
encounters market constraints when trying to convert assets into cash or to
access financial market or sources of funds), and contingent liquidity risk
(when unexpected events cause the bank to have insufficient funds to meet its
obligations due to firm-specific factors like rating downgrade, large
operational losses or external factors like severe economic slowdown, general
market dislocation).
In general, a
bank is said to be liquid if the bank is able to provide money to its customers
trying to withdraw and on the contrary, a bank is said to be illiquid if the
customers try to withdraw more money from the bank than it can accommodate.
All the
scheduled banks have to manage liquidity from two perspectives. First one to
address regulatory requirement like Cash Reserve Ratio (CRR) while the second
one to meet the contractual obligations to fulfill the demand from the
depositors. The country's banking sector had long been experiencing with ample
liquidity. Addressing to this phenomenon Central Bank had to increase the volume
of 7/14/30 day Bangladesh Bank Bills to help balancing the market liquidity.
However, of late, the market has seemingly been facing liquidity crunch, though
the market still remains very much liquid at least for the very short term
i.e., overnight.
This is evident
from the interbank overnight call money rate which has been hovering around
3%-4% on average. Had the market been not so liquid (as opposed to name it as
'illiquid'), the interbank overnight lending/borrowing rate might not stand at
such low level, if not be reached at the record high level which happened
during December 2010! Addressing to meet depositors obligations banks have to keep
sufficient cash in vault.
But practically
banks do not keep all of its deposits mobilized in cash for immediate
withdrawal (through the counter or through ATMs). From regulatory perspective
banks are allowed to extend loan up to 85% and 90% of their deposits mobilized
for Conventional and Islamic (including Islamic window of Conventional banks)
respectively and therefore, 15% and 10% of deposits are left with them.
Therefore, it is
evident that a small amount of cash stocked in vault and ATMs are kept by the
banks. Now, it may hardly happen that all depositors come together to withdraw
their funds. This may happen only when banks face severe liquidity crunch. In
such a situation the bank facing liquidity crunch cannot meet contractual
obligations and failed to provide depositors intend to withdraw their funds.
Because when a depositor cannot withdraw her/his fund s/he informs other
depositors that this bank is not able to provide funds.
Following these incidents the regulatory caps on ADR are
likely to have a downward revision in a while to 80% and 85% from existing 85%
and 90% for conventional and Islamic banks respectively since such occurrence
in a particular bank is more than enough to put the entire banking system into
a reputational and most importantly, liquidity risk. This is definitely a
stressful time but the banks need to try keeping things on an even keel as much
as possible.
Banks are the
most important financial institutions that are involved in the financing of the
economy. The investment banks are based on liquidity potential. Insufficient
capital can limit the basic banking function based on collected deposits and granted
credits. Even banks are face to a potential entrepreneur; they may refuse
financing this agent when they feel that liquidity is not sufficient. It
results in an opportunity loss for the banks (Diamond & W.Rajan, 2001) . Hence, liquidity is
considered as the main pillar that affects banks’ performance and survival.
Literature based on the relationship on this topic provided two groups. The
first one studied the relation between liquidity and bank performance. The
second one investigated the association between liquidity risk and bank
profitability.
There were
several studies that analyzed the effect of liquidity and/or liquidity risk on
bank performance. Following the liquidity risk issues from the 2007 financial
crisis, Cuong Ly (2015) investigated the association between liquidity risk and
the performance of European banks. The sample used in this study is composed of
a panel of EU27 observed during 2001-2011. The major findings of this research
confirm a negative relationship between liquidity risk and bank performance.
Another study that focused on the European context was done by Cucinelli
(2013). In this study, the author studied the relationship between liquidity risk
and probability of default. Using a sample of 575 listed and non-listed banks
and based on the OLS regression, results indicate that there is no significant
association between liquidity and probability of default in the long term.
John and
Olusegun (2015) studied the impact of liquidity on the Nigerian bank
performance. They used a sample of 13 banks during the period 2004-2012.
Results of GMM regression provide a positive relationship between liquidity and
bank performance. They reported that banks should improve their liquidity to be
more efficient.
3.4 Managing Liquidity Risk
A severe
liquidity crisis may develop into a comprehensive capitalization disaster
within a short period. This state may grow due to fire-sale risk affecting
illiquid assets. This passion sale risk may also effect the balance sheet
because the organizations are obliged to mark their assets to the fire-sale
price. Banks can evade this crisis by focusing on the ratios like liquid
liabilities to total liabilities and liquid assets to total assets (Goddard,
Molyneux, & Wilson, 2009) .
On other hand, a
bank may recover the maturity renovation by holding extremely liquid assets as
these assets can be pledged or sold to encounter the funding risks in a small
time (Goodhart, 2008) . A bank may have to
upsurge its cash reserves to alleviate the liquidity risk, but it may be costly
in exercise (Holmstrom & Tirole, 2000) . The liquidity of an
asset must be built on its volume to generate the liquidity, in place of its
trading book arrangement or its accounting action (CEBS, 2008). CEBS, 2008;
additional highlights to uphold a liquidity barrier, encompassing of liquid
assets and cash. This barrier cushions the liquidity stress in a “persistence
period”.
Liquidity risk
management is a vital component of the global risk management agenda of the
financial services sector, regarding all financial institutions (Majid, 2003).
Preferably, a well-managed financial institute should have a precise mechanism
for the identification, monitoring, measurement and mitigation of liquidity
risk (Comptroller of the Currency, 2001). The system helps the banks in timely
acknowledgment of the bases of liquidity risk to elude losses. The balance
sheets of banks are emergent in complication and reliance upon the capital
markets has made the liquidity risk management more challenging. The banks
having improved exposure in the capital markets must have a profound
understanding of the risks. These banks should improve the mechanism required
for appropriate risk management and measurement. The bank should have unceasing
cognizance about the failure of its various funding sources in terms of
‘separate bands of clientele’ (individual patrons, traders, etc) and
instruments and financial markets (Falconer, 2001).
Furthermore, the
BB imposes the regulation to maintain cash reserve requirement (a least
quantity that a bank is compulsory to maintain at all eras of its operations)
to overawed the liquidity glitches. A bank always efforts to avoid the capital
dose from the government since this may place a given bank at the government’s
compassion. Therefore, banks grip minimum cash amount to avoid liquidity
hitches (Jenkinson, 2008) .
In spite of its
structures to support funding and upsurge liquidity, Ali (2004) has explained
two main disadvantages of the above-stated policy. Frist, it takes time to be
matured. Many of the advancing decisions are taken in advance and hard to be
upturned promptly, thus not making liquidity drainage rapidly. Second,
condensed lending covers a large part of the economy. In the non-availability
of capitals to households and companies, it becomes problematic to attention
consumption and long-term investment in the economy.
One conceivable
security measure to decrease liquidity pressure is the change of illiquid
assets into cash. In times of enormous funding burden, securitization methods
are usually employed by the banking system for liquidation of assets like
hypothecations. A bank should resort to funding deficit by acting on the assets
side of the balance sheet if it is confronting limitations on rising liquidity.
It will be forced to crush the progression of loans to its clients to decrease
funding supplies.
The deposits
deliver a natural hedgerow to banks against the liquidity risk. Under the
worried market situations, the banks are supposed as a harbor for investors who
do not mean to issue funds against their loan promises (Gatev &
Strahan, 2003) .
The cash movements in any bank accompaniment each other. The invasions of funds
give a natural hedgerow to banks for discharges due to loan advancements. So,
banks use deposits to hedgerow the liquidity risk. This quarrel also finds
provision from the work of who delivered a basis of risk management to describe
the features of a commercial bank, usually branded as “financial intermediary”
joining demand deposits with loan promises.
3.5 Research Hypotheses
H1: There is a significant positive
relationship between Gross domestic product (GDP) and Loan to Deposit
of the banks.
H2: There is a
significant negative relationship between Nominal interest rate and Loan to
Deposit of the banks.
H3: There is a
significant negative relationship between cash reserve and Loan to Deposit of
the banks.
H4: There is a
significant positive relationship between Investment incomes and Loan to
Deposit of the banks.
H5: There is a
significant negative relationship between Other Operating Expenses and Loan to
Deposit of the banks.
H1: There is a significant positive relationship
between Gross
domestic product (GDP) and Loan to Deposit
of the banks. (The Loan to Deposit of the bank boosts up due to increase in Gross domestic product (GDP).
Gross domestic product (GDP) is
a monetary measure of the market value of all final goods and services produced
in a period (quarterly or yearly) of time. Nominal GDP estimates are commonly used to determine the economic
performance of a whole country or region, and to make international
comparisons.
H2: There is a significant negative relationship
between nominal interest rate and Loan to Deposit of the banks. (The Loan to
Deposit of the bank decreases due to increase in the nominal interest rate)
A nominal
interest rate is the interest
rate that does not take inflation into account. It is the interest rate that is quoted on bonds
and loans. As opposed to the nominal
interest rate, the real interest
rate adjusts for the inflation and gives the real rate of a bond or a loan.
H3: There is a significant negative relationship
between cash reserve and Loan to Deposit of the banks. (The Loan to Deposit of
the bank decreases due to increase in cash reserves)
Every bank
attempts to keep adequate funds to meet the unforeseen demands from savers
(Majid, 2003) but preserving the cash is extremely costly (Holmstrom &
Tirole, 2000). If banks preserve huge cash reserves it may not only drop a
number of opportunities in the marketplace but the bank would also have to bear
the great cost related with cash.
H4: There is a significant positive relationship
between Investment incomes and Loan to Deposit of the banks. (The Loan to
Deposit of the bank boosts up due to increase in Investment incomes)
Investment income comes from interest payments, dividends, capital gains
collected upon the sale of a security or other assets, and any other profit
made through an investment vehicle
of any kind. Generally, most people earn a large portion of their total
net income through
employment income.
H5: There is a significant negative relationship
between Other Operating Expenses and Loan to Deposit of the banks. (The Loan to
Deposit of the bank decreases due to increase in the Other Operating Expenses)
Other operating expenses, also known as overhead expenses, is the amount which generally does not depend on sales
or production quantities. These include, for example, marketing expenses, rent and utilities,
office expenses, operating leases, IT (software
services) and other fixed
costs.
Research Methodology
4.
Research Methodology
The following methodology has been followed
in the study:
4.1
Sample Design
The data for
study and analysis have been taken from annual reports of 10 private commercial
banks in Bangladesh. The data have been collected for a set of 10 banks for the
period 2007-2016. The obtainability of data verbalized the choice of 10 banks
that explanation for the majority of the total assets of the 10 private
commercial banking industry. The nature of data is panel data as it is a
combination of time series and cross sectional data. Because of the small extent
of the sample period (2007-2016) and a small value of degrees of freedom, the
cross section (10 banks) and time series (2007-2016) data is transformed into
panel data thus overcoming the degrees of freedom problems.
4.2 Data Collection
This report is fully
qualitative and quantitative completed by secondary sources of data analysis.
To accomplish the report secondary data is necessary. Secondary data is
collected through different files, manual, books, statement, journals,
articles, and website and so on.
The secondary data on
deposits, Investment Income, loan, Cash, Other operating Expenses of all the
scheduled banks in the study have been collected from 10 private commercial
Banks in Bangladesh.
The selected 10 private
commercial Bank in this report:
·
UCB
Bank Limited
·
AB
Bank Limited
·
Eastern
Bank Limited
·
BRAC
Bank Limited
·
The
City Bank Ltd.
·
Dhaka
Bank Limited
·
Dutch-Bangla
Bank Limited
·
EXIM
Bank Limited
·
IFIC
Bank Limited
·
Prime
Bank Ltd
A sample of 10
private commercial banks is taken to measure and evaluate the effect of
liquidity risk of banks. The income statement, balance sheets and their notes
have been considered to acquire the data for the variables stated in the
developed model. All values which are taken for nominated variables are in Bangladeshi
Taka. The explanation of these variables is as follows:
Loan to Deposit: Loan to Deposit Ratio. The formula for the loan to deposit ratio is exactly as its name implies, loans divided by deposits. The loan to deposit ratio is used to
calculate a lending institution's ability to cover withdrawals made by its
customers.
Gross domestic product (GDP):
GDP taken from Bangladesh Bank annual report of the real economic sector part. Gross domestic product (GDP) is
a monetary measure of the market value of all final goods and services produced
in a period (quarterly or yearly) of time.
Nominal Interest
rate: Nominal Interest rate taken Bangladesh
Bank balance sheet. A nominal interest rate is
the interest rate that
does not take inflation into account. It is the interest rate that is quoted on bonds and loans.
Cash: Data for the cash are taken from the
assets side of balance sheets of banks. This includes “cash and balance with
the treasury bank” only. “Accounts with other banks” have not been incorporated
in cash.
Investment income: The data for Investment income are taken from
the assets side of
balance sheets of banks .Investment income
refers solely to the financial gains above the original cost of the investment.
The form the income takes, such as interest or dividend payments, is irrelevant
to it being considered investment income as long as the income is generated due
to a previous investment.
Other Operating Expenses: Data for the Other Operating
Expenses
are taken from the Profit and Loss Account of banks. In this terms includes all
overhead expenses such as: rant, utilities, and
office expenses.
Deposits: Deposits are accounts of the customers
of banks. The data for deposits are taken from the liability side of balance
sheets without any classification of current or other types of deposit
accounts.
Loan: Loan and Advance taken from Balance
sheet of banks. Loan is a kind of
debt while Advances are
credit facility granted to customers by banks. Loans are provided for long duration which is just opposite
in the case of Advances.
In order to
empirically investigate the relationship between the selected variables, I use
a linear regression model, which is widely used in the literature:
4.3 Regression Model
Y Loan to Deposit=a+b1Cash+b2Investment income+b3Other
operating expenses+b4Gross domestic product (GDP) +b5Nominal Interest Rate
Where
Y is the dependent
variable
X is the
independent variable
b is the
slope
a is the
y-intercept
The estimated
model was tested so as the errors to be normally distributed, independent and
with constant variance (homoscedasticity condition). Furthermore, the
simultaneous inclusion of certain variables did not raise concerns of multicollinearity
as the tests performed have indicated.
Dependent
variable:
Y= Loan to Deposit
Independent
Variable:
Macro Variable
X1= Gross domestic product (GDP)
X2= Nominal
Interest Rate
Micro Variable
X3= Cash
X4= Investment income
X5= Other Operating Expenses
Data Analysis and Findings
5.
Data Analysis and Findings
This Research
applied Multiple Regressions to test the model. The mean value of “Loan to
Deposit” is significantly positive.
5.1
Dependent and Independent Variable Item Calculation
The dependent and independent
variable are collected form annual report of 10 private commercial bank in
Bangladesh. The dependent variable is Loan to Deposit Ratio. The formula for the loan to deposit ratio is exactly as its name implies, loans divided by deposits. The independent Micro variable cash, Investment income and
other operation expenses directly collected from balance sheet. The Macro
variable GDP and nominal interested rate collected from Bangladesh bank annual
report.
5.2 Summary Output
Interpret Regression Statistics Table.
This is the following
output. Of greatest interest is R Square.
Regression
Statistics
|
|
Multiple R
|
0.827988524
|
R Square
|
0.685564996
|
Adjusted R Square
|
0.661640594
|
Standard Error
|
1.66024208
|
Observations
|
100
|
R Square:
R-squared is a
statistical measure of how close the data are to the fitted regression line. It
is also known as the coefficient of determination, or the coefficient of
multiple determination for multiple regression.
From the table
it can be observed that R Square equals 0.686, which is good fit. 69% of the
variation in Loan to Deposit is explained by the independent variables;
Investment income, deposit, Other Operating Expenses, Cash and Loan/Advance.
The closer to 1, the better the regression line fits the data.
Multiple R:
Multiple R is
the Square root of R2. Multiple R square 0.83 implies that there is
a strong positive relationship among the
variables.
Adjusted R Square:
The adjusted
R-squared is a modified version of R-squared that has been adjusted for the
number of predictors in the model. Based on the number of independent variable
R-squared is influenced. Here the adjusted R square decreases to 0.66 because
of predictors improve the model by less than expected by chance. Adjusted R
square is always lower than the R-squared.
Standard Error
This is also
referred to as the root mean squared error. It also refers to the estimated
standard deviation of the error term. It is sometimes called the standard
error of the regression. It equals sort (SSE/ (n-k)).
Observation: Total number of observation equals to
100 considered for conducting the study
5.3
Interpretation of ANOVA Table
An ANOVA table
is given below
ANOVA
|
||||||
df
|
SS
|
MS
|
F
|
Significance F
|
||
Regression
|
7
|
552.9023173
|
78.98604532
|
28.65546998
|
1.45517E-20
|
|
Residual
|
92
|
253.5891463
|
2.756403764
|
|||
Total
|
99
|
806.4914636
|
The Analysis of
Variance table is also known as the ANOVA table (for Analysis Of Variance). It
tells the story of how the regression equation accounts for variability in the
response variable.
The column
labeled Source has three rows: Regression, Residual, and Total. The column
labeled Sum of Squares describes the variability in the response variable, Y.
df = n-1=100-1=99
The
column labeled significance F has the associated P-value.
At Significance
level 0.05, the model is significant
since 1.45517E-20
< 0.05
5.4 Interpret Regression Coefficients Table
The regression output of
most interest is the following table of coefficients and associated
output:
Coefficients
|
Standard Error
|
t Stat
|
P-value
|
Lower 95%
|
Upper 95%
|
Lower 95.0%
|
Upper 95.0%
|
|
Intercept (Loan to deposit)
|
5.028899571
|
2.763095151
|
1.82002403
|
0.072007203
|
-0.458845901
|
10.51664504
|
-0.458845901
|
10.51664504
|
GDP
|
-0.162051107
|
0.602588951
|
-0.26892479
|
0.78858972
|
-1.358844777
|
1.034742563
|
-1.358844777
|
1.034742563
|
Nominal Interest Rate
|
0.087945958
|
0.179208133
|
0.490747585
|
0.624773506
|
-0.267976862
|
0.443868778
|
-0.267976862
|
0.443868778
|
Cash
|
-6.3194E-11
|
2.01034E-11
|
-3.14344863
|
0.002247739
|
-1.03121E-10
|
-2.3266E-11
|
-1.03121E-10
|
-2.3266E-11
|
Investment income
|
-8.65435E-12
|
4.26908E-12
|
-2.02721554
|
0.045534032
|
-1.71331E-11
|
-1.7558E-13
|
-1.71331E-11
|
-1.7558E-13
|
Other Operating Expenses
|
-1.24914E-11
|
6.04313E-11
|
-0.20670395
|
0.83669786
|
-1.32513E-10
|
1.0753E-10
|
-1.32513E-10
|
1.0753E-10
|
A simple summary of the
above output is that the fitted line is
Y Loan to
Deposit=a+b1Cash+b2Investment income+b3Other operating expenses+b4Gross domestic
product (GDP)
+b5Nominal Interest Rate
Y Loan to
Deposit = 5.028899571 -0.162051107* Cash +0.087945958* Investment
income - 6.3194 * other
operating expenses -8.65435 * Gross domestic product (GDP) -1.24914* Nominal Interest Rate
From the equation we can say that
When
Cash = Investment
income = other operating expenses = Gross domestic
product (GDP)
= Nominal Interest Rate O then Loan to
Deposit Y=5.028899571
Explanation for each independent
variable’s coefficient & their effect:
A low p-value
(< 0.05) indicates that you can reject the null hypothesis. In other words,
a predictor that has a low p-value is likely to be a meaningful addition to
your model because changes in the predictor's value are related to changes in
the response variable.
H1: There is a significant positive relationship between
Gross domestic
product (GDP) and Loan to Deposit
of the banks. (The Loan to Deposit of the bank boosts up due to increase in Gross domestic product (GDP).
The coefficient
for Gross domestic product (GDP)
is -0.1621. So for every unit increase in Gross domestic product (GDP), a
-0.1621 unit decrease in Loan to Deposit,
holding all other variables constant. The significant level is p < 0.05 so
here 0.7885 is the p-value of this coefficient
i.e. it is significant, so we can told that H2: the null hypothesis is not rejected.
H2: There is a significant negative relationship
between nominal interest rate and Loan to Deposit of the banks. (The Loan to
Deposit of the bank decreases due to increase in the nominal interest rate)
For every unit increase
in nominal interest rate, we expect a
0.0879 unit
increases in Loan to Deposit, holding all other variables constant. 0.6247 is the p-value of this coefficient i.e. it is
insignificant because significant level is p < 0.05. So we can told that H1: the null hypothesis is not
rejected.
H3: There is a significant negative relationship
between cash reserve and Loan to Deposit of the banks. (The Loan to Deposit of
the bank decreases due to increase in cash reserves)
For every unit
increase in cash reserve, we expect a
- 6.3194 unit decreases in Loan to Deposit,
holding all other variables constant. 0.0022 is the p-value of this
coefficient i.e. it is significant because significant level is p < 0.05. So
we can told that H1: the null
hypothesis is rejected.
H4: There is a significant positive relationship
between Investment incomes and Loan to Deposit of the banks. (The Loan to
Deposit of the bank boosts up due to increase in Investment incomes)
The coefficient
for Investment Income is -8.65435. So for every unit increase in investment
income, a -8.65435 unit decrease in Loan to Deposit,
holding all other variables constant. The significant level is p < 0.05 so
here 0.0455 is the p-value
of this coefficient i.e. it is significant, so we can told that H2: the null hypothesis is rejected.
H5:
There is a significant negative relationship between Other Operating Expenses and Loan to Deposit of the banks. (The Loan to
Deposit of the bank decreases due to increase in the Other Operating Expenses)
For every unit
increase in other operating expenses, we expect a -1.24914 unit decrease in Loan to
Deposit, holding all other variables constant. The significant level is p
< 0.05 and the coefficient of p-value is 0.8366 i.e.
it is insignificant, so we can told that H4:
the null hypothesis is not rejected.
From the output
stated above the p-value variables Loan to Deposit, Investment income, deposit
and Loan/Advance the significance level of 0.05, which indicates that it is
statistically significant. Cash and other operating expense is greater than the
significance level of 0.05, which indicates that it is not statistically
significant.
5.5
At 0.05 Significance level:
Variable
|
P-value
|
P-value
|
Intercept(Loan
to Deposit)
|
0.072007203
|
Insignificant
|
GDP
|
0.78858972
|
Insignificant
|
Nominal
Interest Rate
|
0.624773506
|
Insignificant
|
Cash
|
0.002247739
|
significant
|
Investment
income
|
0.045534032
|
significant
|
Other Operating
Expenses
|
0.83669786
|
Insignificant
|
Recommendations
and Conclusion
Recommendations
This study was
intended to identify the determinants of liquidity of 10 private commercial
banks; and hence on the basis of the findings of the study, the following
recommendations were drown
·
Among
the macroeconomic variables included in this study general inflation rate
exists as significant key drivers of liquidity of 10 commercial private banks.
This is a clear signal to all commercial banks in Bangladesh that they cannot
ignore the macroeconomic indicators when strategizing to improve on their
position of liquidity. Thus, banks in Bangladesh should not only be concerned
about internal structures and policies/procedures, but they must consider both
the internal environment and the macroeconomic environment together in
developing their strategies to efficiently manage their liquidity position.
·
Few
banks attempt to carry more cash in their reserves to meet the liquidity risk
that affects the Loan to Deposit of bank as cash is always expensive. Banks
should try to keep up more liquid assets other than cash.
·
Banks
should not take very large exposure in the long-term assets.
·
Banks
should continuously monitor the economic indicators to forecast the demands of
depositors.
·
Special
attention should be given to avoid the maturity mismatch between assets and
liabilities.
·
Liquidity
situation should be periodically monitored by the management of a bank.
·
In
general, the findings of the study reveals that, bank specific variables have
more statistically significant impact on the determination of liquidity of 10
private commercial banks, since they are internal variables that can be controlled
by management, special emphasis shall be given to those significant variables.
Conclusion
Liquidity
problems may negatively and badly upset a given bank’s capital and earnings.
Under extreme conditions, it may cause the failure/collapse of an otherwise
solvent bank. A bank having liquidity glitches may face difficulties in meeting
the demands of depositors. Though, this liquidity risk may be diminished by
raising deposit base, maintaining sufficient cash reserves, decreasing the other
operating expenses and Loan. Sufficient cash reserves reduce the bank's
dependence on the repo market. This decreases the cost related with over the
night borrowing. Furthermore, it also supports the banks to avoid fire sale
risk.
It is vital for
the bank’s management to be alert of its liquidity position in dissimilar
buckets. This may help them in improving their investment portfolio and giving
a competitive advantage in the market. It is the highest priority of a bank’s
management to pay the essential attention to the liquidity issues. These
difficulties should be punctually addressed, and instant remedial measures
should be taken to evade the consequences of liquidity.
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