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LIQUIDITY MANAGEMENT AND FINANCIAL PERFORMANCE OF THE NIGERIA INSURANCE INDUSTRY
ABSTRACT
This study examined the impact of liquidity management and financial performance on the Nigeria insurance industry. Secondary data used in this study were carried from text books, journals, magazines and newspaper. Our findings indicate that there was a positive relationship between liquidity management and the profitability of the Nigeria insurance industry. Based on this findings we recommend that should be prudent in extending credit facilities to their client/customers to avoid problem of load loss management and competence in financial system should be enhanced to increase asset quality.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Liquidity management is a concept that is receiving serious attention all over the world especially with the current financial situations and the state of the world economy. Some of the striking corporate goals include the need to maximize profit, maintain high level of liquidity in order to guarantee safety, attain the highest level of owner’s networth coupled with the attainment of other corporate objectives. The importance of liquidity management as it affects corporate profitability in today’s business cannot be over emphasised. The crucial part in managing working capital is required maintenance of its liquidity in day-to-day operation to ensure its smooth running and meets its obligation (Eljelly, 2004). Liquidity plays a significant role in the successful functioning of a business firm.
Liquidity entails meeting obligations as they fall due and striking a balance between the current assets and current liabilities. Jensen (1986) observes that companies are strained when their level of liquidity is low and have negative working capital. This is because either inadequate liquidity or excess liquidity may be injurious to the smooth operations of the organization (Janglani and Sandhar, 2013). Almeida et al (2002) proposed a theory of corporate liquidity demand that is based on the assumption that choices regarding liquidity will depend on firms’ access to capital markets and the importance of future investment to the firms. The model predicts that financially constrained firms will save a positive fraction of incremental cash flows, while unconstrained ones will not. The cost incurred in a cash shortage is higher for firms with a larger investment opportunity set due to the expected losses that result from giving up valuable investment opportunities. A liquid company takes advantage of available investments, cash discounts and lower interest charges on borrowings. Hence there is a relationship between cash holdings and investment opportunity and thus financial performance.
The difficulties experienced by some banks and other financial institutions during the financial crisis were due to lapses in basic principles of liquidity management. In response, as the foundation of its liquidity framework, the Committee in 2008 published Principles for Sound Liquidity Risk Management and Supervision (“Sound Principles”). Liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses (Basel Committee on Banking Supervision, 2013). The liquidity of an asset depends on the underlying stress scenario, the volume to be monetized and the timeframe considered. Therefore, efficient and effective liquidity management is crucial if the survival and prosperity of firms is to be assured. According to the Banking Act (2014) and CBK Prudential Guideline (2013), an institution shall maintain such minimum holding of liquid assets as the Central Bank may from time to time determine. Kenyan banks are required to maintain a statutory minimum of twenty per cent (20%) of all its deposit liabilities, matured and short term liabilities in liquid assets. Liquidity Ratio is determined by net liquid assets and total short term liabilities.
1.2 STATEMENT OF THE PROBLEM
As uncertainty led funding sources to evaporate during the recent financial crises, many financial institutions especially banks quickly found themselves short on cash to cover their obligations as they came due (Bordeleau,2010) . In the aftermath of the crisis, there was a general sense that the institutions had not fully appreciated the importance of liquidity management and the implications of such risk to the firms themselves, as well as the wider financial system. Liquid assets such as cash and government securities generally have a relatively low return, holding them can impose an opportunity cost in a financial institution. In the absence of regulation, it is reasonable to expect companies will hold liquid assets to the extent they help to maximize the firm’s financial performance and profitability. Beyond this, policy makers have the option to require larger holdings of liquid assets, for instance, if it is seen as a benefit to the stability of the overall financial system. The problem becomes how to select or identify the optimum point or the level at which a financial institution can maintain its liquid assets in order to optimize its return. This problem becomes more pronounced as good numbers of institutions especially financial companies are engrossed with profit and performance maximization and as such they tend to neglect the importance of liquidity management.
Problems sometimes also evolve from banks inordinate urge to make phenomenal profit. In the process of doing this there is the tendency for these banks to get carless in the resources utilization and particularly their management of liquidity.
The resultant effect is usually loss substance and consequently, loss accumulation, a situation which can lead to banking failure. The marginal loans in the banking system calls to mind the important factor that national government of all` time preoccupy themselves with banks. This shows the degree of importance attached to liquidity and its management by these governments and deviation from its ratio or inadequacy of it management always spells trouble for the banking concerned.
The far reacting consequences of inadequate liquidity management can also be examined. Apart from profit declines. Other of attendant consequences to a bank includes loss of confidence in the particular bank its inability to fulfill both its short term and long-term obligation, lack of trust on the part o depositors and other customers alike; and the concomitant reduction in level of operations.
A recent example of the eminent distress facing Nigeria bank which is as a result of improper liquidity position management as well as loan loss- accumulation (marginal loans). These problems make it glaring that there is a need to carry out a study on liquidity management and financial performance of the Nigeria insurance industry.
1.3 OBJECTIVES OF THE STUDY
The general objective for this study is to investigate on liquidity management and financial performance of the Nigeria insurance industry. The specific objectives are:
1. To examine in details the liquidity position of Nigeria insurance industry.
2. To identify causes of illiquidity or factors that influence liquidity management.
3. To examine how the Nigeria insurance industry is able to adjust their liquidity and control management in Nigeria financial environment.
ABSTRACT
This study examined the impact of liquidity management and financial performance on the Nigeria insurance industry. Secondary data used in this study were carried from text books, journals, magazines and newspaper. Our findings indicate that there was a positive relationship between liquidity management and the profitability of the Nigeria insurance industry. Based on this findings we recommend that should be prudent in extending credit facilities to their client/customers to avoid problem of load loss management and competence in financial system should be enhanced to increase asset quality.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Liquidity management is a concept that is receiving serious attention all over the world especially with the current financial situations and the state of the world economy. Some of the striking corporate goals include the need to maximize profit, maintain high level of liquidity in order to guarantee safety, attain the highest level of owner’s networth coupled with the attainment of other corporate objectives. The importance of liquidity management as it affects corporate profitability in today’s business cannot be over emphasised. The crucial part in managing working capital is required maintenance of its liquidity in day-to-day operation to ensure its smooth running and meets its obligation (Eljelly, 2004). Liquidity plays a significant role in the successful functioning of a business firm.
Liquidity entails meeting obligations as they fall due and striking a balance between the current assets and current liabilities. Jensen (1986) observes that companies are strained when their level of liquidity is low and have negative working capital. This is because either inadequate liquidity or excess liquidity may be injurious to the smooth operations of the organization (Janglani and Sandhar, 2013). Almeida et al (2002) proposed a theory of corporate liquidity demand that is based on the assumption that choices regarding liquidity will depend on firms’ access to capital markets and the importance of future investment to the firms. The model predicts that financially constrained firms will save a positive fraction of incremental cash flows, while unconstrained ones will not. The cost incurred in a cash shortage is higher for firms with a larger investment opportunity set due to the expected losses that result from giving up valuable investment opportunities. A liquid company takes advantage of available investments, cash discounts and lower interest charges on borrowings. Hence there is a relationship between cash holdings and investment opportunity and thus financial performance.
The difficulties experienced by some banks and other financial institutions during the financial crisis were due to lapses in basic principles of liquidity management. In response, as the foundation of its liquidity framework, the Committee in 2008 published Principles for Sound Liquidity Risk Management and Supervision (“Sound Principles”). Liquidity is the ability of a bank to fund increases in assets and meet obligations as they come due, without incurring unacceptable losses (Basel Committee on Banking Supervision, 2013). The liquidity of an asset depends on the underlying stress scenario, the volume to be monetized and the timeframe considered. Therefore, efficient and effective liquidity management is crucial if the survival and prosperity of firms is to be assured. According to the Banking Act (2014) and CBK Prudential Guideline (2013), an institution shall maintain such minimum holding of liquid assets as the Central Bank may from time to time determine. Kenyan banks are required to maintain a statutory minimum of twenty per cent (20%) of all its deposit liabilities, matured and short term liabilities in liquid assets. Liquidity Ratio is determined by net liquid assets and total short term liabilities.
1.2 STATEMENT OF THE PROBLEM
As uncertainty led funding sources to evaporate during the recent financial crises, many financial institutions especially banks quickly found themselves short on cash to cover their obligations as they came due (Bordeleau,2010) . In the aftermath of the crisis, there was a general sense that the institutions had not fully appreciated the importance of liquidity management and the implications of such risk to the firms themselves, as well as the wider financial system. Liquid assets such as cash and government securities generally have a relatively low return, holding them can impose an opportunity cost in a financial institution. In the absence of regulation, it is reasonable to expect companies will hold liquid assets to the extent they help to maximize the firm’s financial performance and profitability. Beyond this, policy makers have the option to require larger holdings of liquid assets, for instance, if it is seen as a benefit to the stability of the overall financial system. The problem becomes how to select or identify the optimum point or the level at which a financial institution can maintain its liquid assets in order to optimize its return. This problem becomes more pronounced as good numbers of institutions especially financial companies are engrossed with profit and performance maximization and as such they tend to neglect the importance of liquidity management.
Problems sometimes also evolve from banks inordinate urge to make phenomenal profit. In the process of doing this there is the tendency for these banks to get carless in the resources utilization and particularly their management of liquidity.
The resultant effect is usually loss substance and consequently, loss accumulation, a situation which can lead to banking failure. The marginal loans in the banking system calls to mind the important factor that national government of all` time preoccupy themselves with banks. This shows the degree of importance attached to liquidity and its management by these governments and deviation from its ratio or inadequacy of it management always spells trouble for the banking concerned.
The far reacting consequences of inadequate liquidity management can also be examined. Apart from profit declines. Other of attendant consequences to a bank includes loss of confidence in the particular bank its inability to fulfill both its short term and long-term obligation, lack of trust on the part o depositors and other customers alike; and the concomitant reduction in level of operations.
A recent example of the eminent distress facing Nigeria bank which is as a result of improper liquidity position management as well as loan loss- accumulation (marginal loans). These problems make it glaring that there is a need to carry out a study on liquidity management and financial performance of the Nigeria insurance industry.
1.3 OBJECTIVES OF THE STUDY
The general objective for this study is to investigate on liquidity management and financial performance of the Nigeria insurance industry. The specific objectives are:
1. To examine in details the liquidity position of Nigeria insurance industry.
2. To identify causes of illiquidity or factors that influence liquidity management.
3. To examine how the Nigeria insurance industry is able to adjust their liquidity and control management in Nigeria financial environment.
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