A survey of liquidity management approaches and their effect on profitability of commercial banks in Kenya

Abstract

Liquidity has been generally defined as the ability of commercial banks to fund increases in assets (advances) and meet obligations (depositors' claims) as they become due. Liquidity is of two types: Liquidity of assets and that of liability Illiquidity of assets refer to the inability to sell assets at current market prices. The liquidity instability of liability (UL) refers to the inability to obtain sufficient funds to meet payment obligations in a timely manner (instability of deposit base over a long period of time). Banks create liquidity on the balance sheet by transforming less liquid assets into more liquid liabilities. This suggests that Banks may also create significant liquidity off the balance sheet through loan commitments and similar claims to liquid funds. The study had the objective of identifying the liquidity management theories employed by commercial banks in Kenya and study relationship between bank liquidity management approaches and bank profitability. The study findings reveal that the most popular theory with bankers is Commercial loan theory the next is Asset liability management theory, the evidence of use of shiftability and anticipated income theory is weak. However, there was one firm that employed a hybrid strategy i.e. anticipated and commercial loan theory. All the respondents were at senior management level with professional qualifications in banking. From the study it is evident the most common type is commercial and industrial loans. However, consumer loans are becoming more popular. The liquidity levels seem not to depend on particular theories, again because a number of approaches are employed by a particular bank.