Explaining Bank Liquidity in Ghana

ABSTRACT

Holding adequate liquidity is very crucial for the survival of banks. Nevertheless, reserving liquidity in excess hinders the development of interbank markets and suggests that banks are forgoing financial intermediation (hence, returns) and are inefficient. It is against this background that this study sought to find explanations on why bank liquidity in Ghana has for about a decade now remained above global average levels. In attaining this objective, I argued that a more complete liquidity indicator will be a better measure than the traditional measures. With an unbalanced data set of 22 banks over a 7-year period spanning 2007 to 2013, the ratio of liquidity created to total assets is constructed. This ratio captures illiquidity and as such, is employed as an indirect measure of bank liquidity. Subsequently, based on the Hausman’s test, the random effects model is utilized in estimating the factors that explain bank liquidity in Ghana. Findings of the study confirmed that, indeed, Ghanaian banks are highly liquid. Capital, size, ratio of loans to total assets and annual average inflation showed a positive and significant relationship with liquidity.Net interest margin, industry concentration and GDP growth rate exhibited a negative significant relationship with liquidity of banks. Growth in money supply was insignificant in explaining liquidity of banks. The study recommended that, the Central Bank considers the more comprehensive way of measuring liquidity as it quantifies liquidity creation, which is an important function of banks. It is also a good predictor of financial crunches and is a more complete measure of bank liquidity unlike the traditional measures. It is also recommended that banks decrease their equity, net interest margins and the ratio of loans to total assets to cut down excess liquidity reserves. Policies that enhance competition should also be enacted if the need be to further boost liquidity.