Relationship and Behavior of Liquidity and Profitability in Commercial Banking Industry of Ethiopia
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Date
2016-06
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Addis Ababa University
Abstract
Resilient and profitable banks can contribute immensely to the development of financial sector in particular and the country’s development in general. The study employed autoregressive distributed lag (ARDL) to examine the relationship and behavior of liquidity and profitability of the commercial banking industry in Ethiopia. Quarterly consolidated financial statements of fifteen commercial banks that covers the period 2003Q2 – 2014Q3 is used for this study. Augmented Dickey Fuller (ADF) is used to test for unit root. In attempt to draw valid conclusion, diagnostic tests are carried out for serial correlation, heteroscedasticity, and normality. In order to check the stability of long-run coefficients that form the error-correction term in combination of short-run dynamics, cumulative sum of recursive residuals test (CUSUM) and the cumulative sum of squares of recursive residuals test(CUSUMQ) is applied to the residuals of the models. The estimation result of the error correction model shows that the speed of adjustment of liquidity and profitability to long run equilibrium is faster in the commercial banking industry of Ethiopia. The results of ARDL estimation shows that loan growth, bank size, credit risk, saving deposit growth, demand deposit growth, and fixed deposit growth are key determinants of liquidity both in the short and long term. While non-interest income and operating expenses management are the key determinants of profitability both in the short and long term. The result of pairwise Granger causality test shows that neither unidirectional nor bidirectional pattern of causality exists between liquidity and profitability.
Key words: ARDL, Liquidity, Profitability, Granger causality, Error correction model, Commercial banking industry
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Keywords
ARDL, Liquidity, Profitability, Granger causality, Error correction model, Commercial banking industry