Effect of Liquidity Risk on Stock Returns of Commercial Banks Listed at the Nairobi Securities Exchange

Abstract

Effective management of the liquidity position of a firm is considered as a fundamental business function for all sizes of business whether small, medium or large. This is because when a firm does not manage its liquidity well, it will have challenges in meeting its financial obligations when they fall due to inadequate of cash. Most businesses worldwide, whether developing or developed have failed mainly due to liquidity starvation. This study sought to determine the effect of liquidity risk on stock returns of listed commercial banks at the NSE. The study’s population was all the 11 commercial banks quoted at the NSE. The independent variable for the study was liquidity risk as measured by the ratio of customer deposits to total gross loans. The control variables were capital adequacy as measured by the ratio of gross loans and advances to total assets and bank size as measured by natural logarithm of total assets. Stock returns was the dependent variable which the study sought to explain and it was measured by changes in stock price. Secondary data was collected for a period of 5 years (January 2013 to December 2017) on an annual basis. The study employed a descriptive cross-sectional research design and a multiple linear regression model was used to analyze the association between the variables. Data analysis was undertaken using the Statistical package for social sciences version 21. The results of the study produced R-square value of 0.264 which means that about 26.4 percent of the variation in the listed commercial banks’ stock returns can be explained by the four selected independent variables while 73.6 percent in the variation of stock returns of quoted commercial banks was associated with other factors not covered in this research. The study also found that the independent variables had a strong correlation with stock returns (R=0.514). ANOVA results show that the F statistic was significant at 5% level with a p=0.001. Therefore the model was fit to explain the relationship between the selected variables. The results further revealed that bank size produced positive and statistically significant values for this study while liquidity risk and capital adequacy were found to be statistically insignificant determinants of stock returns of listed commercial banks. This study recommends that measures should be put in place to enhance bank sizes among commercial banks as this will improve their stock return