Effect of liquidity risk on the performance of banks in Ethiopia: The case of selected private commercial banks.
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Date
2024-06-19
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A.A.U
Abstract
This study investigates the Effect of liquidity risk on the financial performance of commercial banks,
with a specific focus on Ethiopian banks. The analysis employs data from Ethiopian commercial banks,
encompassing financial statements and relevant economic indicators, ten commercial banks operating
in Ethiopia over a period of ten years were selected based on their performance and years of
establishment. The study analyzed seven variables that are known to influence the financial
performance of commercial banks. Panel data analysis was conducted using data from 2013 to 2022,
resulting in a total of one hundred observations. To indicate the effect of liquidity risk on the
performance of banks financing gap ratio (FGR), liquid asset to total asset ratio (LATAR), loan-toasset
ratio (TLA), cash reserve ratio (CRR), bank size, GDP growth rate, and inflation rate were used
in this study while the financial performance of commercial banks was measured by the Net Interest
Margin (NIM).The study employed descriptive statistics to present the data, followed by a correlation
matrix and regression analysis. Before running the regression analysis, a model specification test was
used to select an appropriate model that satisfied the assumptions of a classical linear regression
model. Based on the results of the model specification test, a random effects model was chosen for the
study. The multiple regression analysis revealed that the Financing Gap Ratio (FGR) has a positive
and statistically significant effect on NIM. This suggests strategic management of financing gaps, a key
liquidity risk variable, is associated with higher profitability for Ethiopian banks. However, other
variables like Liquid Asset Ratio (LATAR), Loan-to-Asset Ratio (TLA), Cash Reserve Ratio (CRR),
bank size, GDP growth, and inflation did not have significant individual effects on NIM. Additionally,
the analysis identified significant variation in NIM across different bank groups. In Conclusion this
study highlights the importance of strategic liquidity management for Ethiopian banks while
maintaining adequate liquidity is crucial, actively managing financing gaps can contribute to higher
profitability. Further research is needed to explore the reasons behind the non-significant effects of
other variables and the observed group-level heterogeneity in NIM.
Keywords: liquidity risk, financial performance, commercial banks, financing gap, panel data
analysis, random effects model.