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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.
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