2.2. Determinants of Liquidity Risk and Bank Profitability
Liquidity and profitability are the most commonly used indicators to assess financial performance and efficiency in bank management (Chinoda 2014
; Noman et al. 2015
; Rahman et al. 2015
; Islam and Nishiyama 2016
). Liquidity can be defined as banks’ ability to finance the increase in their assets and to meet their obligations, without incurring unexpected losses (Vodová 2011
). As Singh and Sharma
) indicate, banks that have an adequate level of liquidity guarantee fulfilment of their financial commitments and obligations towards depositors and thereby ensure greater public confidence. Determining the optimum level of liquidity is critical for banks’ management: Excess liquidity can cause banks’ profitability to decline, while a shortage of liquidity will make it difficult to meet their obligations (Vodová 2011
; Singh and Sharma 2016
). Profitability is the bank’s ability to make a profit from its business by investing its assets. This is an indicator that also measures the efficiency of management and the bank’s competitive position in the market, from the point of view of both assets and equity (Petria et al. 2015
Studies on determinants of bank liquidity were carried out by: Delechat et al.
) in Central America, Panama and the Dominican Republic; Vodová
) and Cucinelli
) in the euro area; Moussa
) in Africa, specifically, in Tunisia; and Singh and Sharma
) in Asia. Delechat et al.
) found that the demand for liquidity, in a preventive manner, is associated with measures such as banks’ size, profitability, capitalization and financial development and that greater liquidity is also associated with the dollarization of deposits. Vodová
) concluded, for Czech banks, that their liquidity is higher when capital adequacy and loan interest rates are higher. Additionally, liquidity measures identify a positive relationship with capitalization and the size of the bank. For the Eurozone, Cucinelli
) showed that larger banks have greater exposure to liquidity risk, while banks with higher capitalization have better liquidity in the long run. Moussa
) showed that financial performance, total assets, operating costs, GDP growth rate, inflation rate and lagged liquidity have a significant impact on bank liquidity. On the other hand, loan dimension, financial costs and total deposits do not have an impact on bank liquidity. Singh and Sharma
) found that the bank’s specific (except the cost of financing) and macroeconomic (except unemployment) factors significantly affect its liquidity, including the variables of margins, deposits, profitability, capital adequacy, GDP and inflation. Additionally, bank size and GDP have a negative effect on bank liquidity.
Regarding the determinants of bank profitability, studies carried out include, for example: In the euro area, Athanasoglou et al.
) and Petria et al.
); in the United States of America Chronopoulos et al.
); in Asia, Al-Jafari and Alchami
), Noman et al.
), Rahman et al.
), Islam and Nishiyama
), Mehta and Bhavani
) and Gharaibeh
); in Africa, Chinoda
); and at a multinational level, (Bourke 1989
; Molyneux and Thornton 1992
; Sahyouni and Wang 2018
). Athanasoglou et al.
) and Petria et al.
) evaluated the main determinants of bank profitability in Europe. Using unbalanced panel data for the period 1998–2002, Athanasoglou et al.
) conclude that with the exception of liquidity, all of a bank’s specific determinants significantly affect its profitability. Regarding macroeconomic variables, inflation affects profitability positively and significantly and real GDP per capita has no significant effect. Petria et al.
) showed that credit and liquidity risk, management efficiency, business diversification, market concentration/competition and economic growth influence banks’ profitability in the period 2004–2011. In the US, Chronopoulos et al.
) analyzed banks from 1984 to 2010. The results showed that the competitive process reduces profitability, although not immediately. The financial crisis of 2007–2010 seems to have resulted in an increase in the persistence of banks’ profitability. Ting
) investigated the effects of financial development and government involvement on bank profitability, during the 2008 financial crisis. The results show that a positive effect of improved financial development is stronger on banks with weak government involvement than on banks with strong government involvement. In another context, Batrancea et al.
) showed that the global financial crisis was related to problems in regulating the banking system, which were solved by injecting liquidity into the system. It is relevant to take this into account to solve or avoid possible crises in the future.
In the Middle East, Al-Jafari and Alchami
) investigated the Syrian banking sector, using the generalized method of moments covering the period from 2004 to 2011, showing that banks’ specific determinants (liquidity risk, credit risk, bank size and administrative efficiency) significantly affect their profitability, as well as macroeconomic variables (inflation rate and real GDP growth rate). Noman et al.
) indicated that credit risk, cost efficiency, GPD growth and the real interest rate affect profitability negatively, while capital adequacy, liquidity, size, inflation and profitability of the stock market have a positive impact. Rahman et al.
), demonstrated that capital adequacy, bank size and loan intensity have positive and significant impacts on profitability, while inflation, the cost-to-income ratio and off-balance sheet have negative and significant impacts on banks’ profitability. Islam and Nishiyama
) showed a low level of persistence of profitability and a late impact of the global financial crisis on the banking sector in several Asian countries. Moreover, the authors found that financial solvency, management excellence, and interest and inflation rates have a positive influence on profitability while the cost of funding, liquidity, the financing gap, the term structure of the interest rate and economic growth have a negative influence. Mehta and Bhavani
) found evidence that cost efficiency, complementary margin and asset quality are the bank’s most significant specific variables for measuring profitability. GDP has a positive influence on the return on assets and return on equity, while the inflation rate does not affect profitability. Gharaibeh
) studied banks in Bahrain, finding that the capital adequacy ratio, the 2008 global financial crisis, the strength of capital, interest rate, the debt ratio and type of bank are the main determinants of commercial banks’ profitability.
In Africa, Chinoda
) identified that internal factors are the main determinants of banks’ profitability, while inflation reduces credit expansion, contributing to higher margins of net interest. Sahyouni and Wang
) investigated a wide range of banks in 11 developed and emerging countries during the period between 2011 and 2015, concluding that banks that create more liquidity are associated with lower profitability. Additionally, asset management, bank size and capital ratio are positively correlated with banks’ profitability. On the other hand, credit quality and operational efficiency affect banks’ profitability negatively. Moreover, the effects of inflation and GDP growth on bank profitability are statistically significant in developed countries, while inflation does not significantly affect the profitability of banks’ assets in emerging countries.
The empirical results of studies on the determinants, both of liquidity risk and bank profitability, differ significantly from country to country. However, most studies focus on common factors that significantly influence both liquidity risk and bank profitability. The literature generally divides them into two groups: Internal factors, specific to banks, and external factors, specific to the sector and to macroeconomics (Petria et al. 2015
). In the case of internal factors, we can highlight factors such as bank size, credit risk, liquidity, efficiency of management, capital adequacy and concentration of the banking system, while in the case of external factors we have, for example, inflation rate and economic growth rate, real interest rate, unemployment rate and GDP per capita.
It is still necessary to highlight the difference between the functional philosophy of Islamic banks in relation to Western banks (Moussa 2015
; Alzoubi 2017
; Mehta and Bhavani 2017
; Gharaibeh 2018
). For example, studies on determinants of bank profitability in Bangladesh by Noman et al.
) and by Rahman et al.
) in similar periods, but applying different methodologies, reached the same conclusions in the following aspects: The size of the bank and capital adequacy affect banks’ profitability positively, while the cost-to-income ratio has negative effects on their profitability. However, differences stand out: Credit risk, GDP growth and the real interest rate affect banks’ profitability negatively in the study by Noman et al.
) and positively in the study by Rahman et al.
In Europe, but considering only transition countries, Bonin et al.
) also used an unbalanced panel of a wide set of banks. With the objective of analyzing the differences in banks’ performance, regarding their ownership, the authors find that foreign-owned banks perform better.
The relationship between liquidity and profitability depends on banks’ business models and on the possible risks when granting credit. Maintaining liquid assets will make banks more resistant to liquidity shocks, thus reducing the negative influence from outside. However, at the same time, maintaining many liquid assets can influence negatively the level of profitability generated (Bordeleau and Graham 2010
), because banks lose the opportunity to benefit from a higher return on the use of those assets. Bordeleau and Graham
) found empirical evidence of the relationship between liquid assets and bank profitability, applying panel data from 1997 to 2009 for a sample of large North American and Canadian banks. The results of the study showed non-linearity in the relationship: Profitability increases in banks that maintain liquid assets but there is a point where maintaining a higher level of net assets decreases profitability. In addition, empirical evidence also suggests that the relationship varies depending on the bank’s business model and the state of the economy.
Profitability and liquidity also play an important role in a bank’s development, depending on the time horizon considered. Banks’ short run survival depends on liquid assets (liquidity), while in the long run their survival, growth and expansion depend on their profitability (Diamond and Rajan 2001