The Relationship Between Liquidity Management & Bank Profitability in the UK

This paper examined the effect of liquidity management on Bank profitability. A sample of 20 UK commercial banks were tested over the period 2005-2014; thus covering three important phases of the global financial crisis 2008-09. The first phase is the pre-crisis period 2005-2007. The second phase is the crisis period 2008-2009, and the third phase is the post-crisis or recovery period 2010-2014. The study used pooled panel data method, and the data was collected from Bankscope database. The explanatory variables were a mix of endogenous and exogenous factors, that show the effect of liquidity management on bank profitability. Bank-specific variables included liquidity ratios like the interbank ratio, LADS, LATDB and others, as well as credit quality variables such as LLR to GL and bank size measured by total assets. Exogenous or macroeconomic variables included GDP and CPI. Three dependent variables were used as a measure of profitability; ROAA, ROAE and NIM. The model employs OLS regression method to estimate the results. Results show an upward trend in liquidity holdings; indicating that banks did not manage their liquidity position effectively in the first phase due to incentives such as increasing profits and market share. The crisis period showed a dramatic increase in liquid asset holdings, which possibly means that banks realized the consequences of their liquidity mismanagement, and tried to safeguard their liquidity position. The last phase shows that the trend continues on a similar pattern, signaling that the financial market is going through a period of financial uncertainties. While many studies find a negative relationship between liquidity management and bank profitability, this paper finds a positive relationship between them. The model shows the yearly effect, not just the aggregate effect of the sample period. Moreover, the study discusses the new liquidity regulations framework; Basel III, and the possible impact of its implementation on the profitability of banks