The Relationship Between Liquidity Risk and Financial Performance of Commercial Banks in Kenya

Abstract

Effective management of a firm’s liquidity position is considered one of the important management functions for all businesses, small, medium or large. This is because an ineffective management of a firm’s liquidity will result in a firm facing challenges in meeting its short term financial obligations when they fall due. In addition, effective management of liquidity requirements of a firm is perceived to positively affect the firm performance and market value and as a result it forms part of the company's strategic and operational thinking. The study aimed at establishing the relationship between the liquidity risk and financial performance of commercial banks in Kenya. The study adopted descriptive research design. In addition, the study was cross-sectional in which data was gathered just once over the period 2010 to 2014 and as such, a causal study was undertaken in a non-contrived setting with no researcher interference. Multiple regressions was applied to assess the impact of liquidity risk on banks’ profitability. The study findings was that there has been an increase in value of cash balance over the five year period studied though there has been an increase in the volume of liquidity gap in commercial banks of Kenya over the five year period studied. It was also found that there was positive correlation coefficient between return on assets and customer deposits, cash balance and size of firm though a weak positive correlation between return on assets and liquidity gap existed. The study concluded that liquidity risk not only affects the performance of a bank but also its reputation and this might result in the loss of confidence among the depositors if funds are not timely provided to them. In addition to this, a poor liquidity position may cause penalties from the regulator and therefore it becomes imperative that banks maintain a sound liquidity position at all times. The study recommends that banks should maintain adequate liquidity levels though in the form of short term marketable securities in order to realize profits for the banks.