Business and Economics Journal

The Effect of Liquidity Risk Management on Financial Performance of Ethiopian Commercial Banks (2010-2021)

Abstract

Tolera Tsegaye Benti and Ketema Sime Biru*

Banks are major financial institutions that play a pivotal role in the economic system, diverting financial resources from surplus economic agents to deficit ones. The purpose of this study was to examine the impact of liquidity risk on the financial performance of Ethiopian commercial banks. Liquidity risk management and profitability are key issues in a competitive business environment. Fixed-effect balanced panel regressions were used for data from 13 commercial banks for the sample period of interest from 2010 to 2021. We have selected and analyzed six factors that affect the financial performance of commercial banks in Ethiopia. The results of panel data regression analysis showed that liquidity (LATA), leverage (TLA), and Gross Domestic Product (GDP) had statistically significant effects on financial performance of commercial banks. The Funding Gap Index (FGR), Cash Reserve Ratio (CRR), and Bank Size (SIZE) have no statistically significant impact on central bank financial performance. Liquidity risk has therefore adversely affected the financial performance of Ethiopian commercial banks. The recommendation is that commercial banks may need to review their credit rating methodologies to ensure that only worthy borrowers lend money to reduce the large number of nonperforming loans. Lending should provide borrowers with some form of financial education, guidance, and advice on how to allocate borrowed funds. Commercial banks are required to hold sufficient capital in accordance with bank operating rules. In order to increase the operational efficiency of banks, it is necessary to improve the capacity development of bankers. The recommendation is that commercial banks may need to review their credit rating methodologies to ensure that only worthy borrowers lend money to reduce the large number of non-performing loans. Lending should provide borrowers with some form of financial education, guidance, and advice on how to allocate borrowed funds. Commercial banks are required to hold sufficient capital in accordance with bank operating rules. In order to increase the operational efficiency of banks, it is necessary to improve the capacity development of bankers. Ethiopian commercial banks can achieve profitability by increasing the size of their banks. Banks therefore have an opportunity to benefit from economies of scale by increasing their market share in the Ethiopian banking industry.