How does liquidity affect bank profitability?

14 Pages Posted: 11 Jun 2016 Last revised: 8 Dec 2021There are 2 versions of this paperNumber of pages: 14 Posted: 11 Jun 2016 Last Revised: 08 Dec 2021You are currently viewing th

How does liquidity affect bank profitability?

14 Pages Posted: 11 Jun 2016 Last revised: 8 Dec 2021

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There are 2 versions of this paper

Number of pages: 14 Posted: 11 Jun 2016 Last Revised: 08 Dec 2021

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Number of pages: 14 Posted: 29 Sep 2017

Date Written: June 9, 2016

Abstract

This study examines the effect of liquidity on the performance of Nepalese commercial banks. Investment ratio, liquidity ratio, capital ratio and quick ratio are the independent variables used in this study. The dependent variables are return on equity (ROE) and return on assets (ROA), while one year lagged variables for independent variables are also used to determine the more specific result of the previous years effect on the current years ROE and ROA. The secondary sources of data have been used from annual reports of the banks and supervision report of Nepal Rastra Bank. The regression models are estimated to test the significance and effect of bank liquidity on performance of Nepalese commercial banks.

Correlation between capital ratio and return on equity found to be positive indicating higher the capital ratio higher would be the return on equity. However, the correlation between return on equity and liquidity ratio is found to be negative indicating higher the liquidity in the bank lower would be the return on equity. Further, the correlation is found to be negative for quick ratio with return on equity. Beta coefficients for investment ratio and capital adequacy are positively significant with bank performance, which indicate that increase in investment ratio and capital ratio leads to increase the performance of the banks. However, beta coefficients for liquidity ratio and quick ratio are negative with return on assets and return on equity indicating increased liquidity ratio and quick ratio decreases the return on assets and return on equity of the bank.

Keywords: Capital ratios, investment ratio, liquidity ratio, quick ratio, return on assets, return on equity, lagged variables

JEL Classification: G20

Suggested Citation: Suggested Citation

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