The effect of liquidity risk management on financial performance of commercial banks in Kenya

Abstract

During the early “liquidity phase” of the financial crisis that began in 2007, many banks – despite adequate capital levels – still experienced difficulties because they did not manage their liquidity in a prudent manner. The crisis drove home the importance of liquidity to the proper functioning of financial markets and the banking sector. Prior to the crisis, asset markets were buoyant and funding was readily available at low cost. The rapid reversal in market conditions illustrated how quickly liquidity can evaporate, and that illiquidity can last for an extended period of time (Basel Committee on Banking Supervision, 2013). The aim of this study was to determine the effect of liquidity risk management on the financial performance of Commercial Banks in Kenya. The study adopted a descriptive study design. The population for this research are the 43 listed Commercial Banks in Kenya analyzed for a period from 2010-2013.The results of the study show that a unit increase in liquid assets to total assets ratio decreases return on assets by 1%. A unit increase in liquid assets to total deposits ratio decreases return on assets by 2.2%. A unit increase in borrowings from banks decreases return on assets by 14.2%. Finally the control variable which was asset quality shows that a unit increase in non-performing loans as a proportion of total loans would lead to a 12.4% decrease in return on assets.The study concludes that liquidity risk management has a significant negative relationship with financial performance of commercial banks. Borrowings from banks by commercial banks to meet shorter liquidity needs do have the greatest impact on liquidity at 14.2% and was significant at 5%.The study also concludes that holding more liquid assets as compared to total assets will lead to lower returns to commercial banks in Kenya but the effect of not significant at 5%. Holding more liquid assets as compared to total deposits will lead to lower returns to commercial banks in Kenya and the effect is significant at 5%