Godwin Emefiele, CBN Governor
Godwin Emefiele, CBN Governor

I cannot lay claim to the greatest expertise in the country on bank liquidity management. However, my over twenty-four years with the Central Bank of Nigeria which I left this year as a Chief Bank Examiner, have allowed me some familiarity with the subject. Also, my present position with the NDIC has presented me with ample opportunity to gain more insights into this important topic.
I intend to organise my discussion today by first explaining what liquidity and its management mean, particularly in the context of banking. Next, I shall attempt to relate liquidity or lack of it to risk, since “risk management” is the theme of this seminar. After that, I shall explain the measures of liquidity in Nigerian banking. Finally, the effects of government measures on bank liquidity and the role of the NDIC in bank liquidity problems shall round up the discussion.
Liquidity and Liquidity Management
Liquidity can be defined as the ability of a company to meet its liabilities as and when they fall due. For the banking industry, liquidity refers to a  bank’s ability to meet its demand, savings and time deposit withdrawals as and when such withdrawals are demanded or are due. Defined more broadly for an individual bank, liquidity includes the bank’s ability to meet loan requests that have been considered profitable and safe. For the banking system, liquidity refers to the above state of affairs defined for the individual banks in addition to the availability of facilities for discounting of financial claims to enhance liquidity plus avenues for raising additional funds promptly and cheaply by banks. For example, the availability of a Central Bank’s rediscount window enhances banks’ liquidity, in the same way as the existence of an efficient inter-bank market for borrowing short-term funds.
Liquidity management refers to a bank’s programmes or strategies to be able to meet deposit and loan demands. Examples of such strategies include holding of short-term financial assets (treasury bill and certificates) which are highly marketable, maintaining avenues for short-term accommodation from the Central Bank or other banks and by bidding for a greater volume of deposits. Liquidity management must of necessity involve liquidity planning. Unfortunately, adequate liquidity planning is lacking in many Nigerian banks. Few banks are able to plan for short, medium and long-term liquidity needs. To plan well, the bank must be able to forecast fixture funds’ demand and deposit supplies.
A portfolio of short-term financial securities held by a bank can be easily sold or rediscounted for cash. This approach plus inter-bank borrowings constitute the major sources of liquidity for Nigerian banks. Short-term accommodation by the Central Bank of Nigeria has been an important source of liquidity for banks in liquidity crises in recent times. Inter-bank funds have been relatively scarce and consequently a very expensive source of liquidity again in recent months. Therefore, improved liquidity planning, greater drive for deposits and injection of fresh capital have been avenues available for banks to overcome their current liquidity crises.
At this point, it is pertinent to assess the consequences of a bank’s inability to plan for liquidity. What risks are undertaken by such a bank? These are the issues addressed in the next section of this paper.
Liquidity: Risk and Return
Risk has generally been seen as a situation where actual outcome does not match expected outcome with the result that a loss is sustained. It is common to associate risk with uncertainty. Mao (1969) quotes Knight (1921) as describing risk as a situation where the probabilities of outcomes associated with the situation or loss can be ascertained objectively, while in uncertainty, the probabilities of outcomes are ascertained subjectively. In finance and banking, the two terms tend to be used interchangeably. In some situations, objective probabilities are possible for outcomes whereas in others, only subjective probabilities can be attached to outcomes. The risky situations common in banking relate to credit, interest, inflation and liquidity and we shall examine these briefly.
Credit Risk in Banking
This is the chance that a bank can sustain a loss from its loans and advances portfolio. This is perhaps the risk with the largest loss to Nigerian bankers. It is in recognition of the prevalence and magnitude of these losses that banks are required to make adequate provision for bad and doubtful debts. In fact section 10 (1) (b) of the 1969 Banking Act stipulates that no licensed bank shalt pay any dividend on its shares until adequate provision for bad and doubtful debts have been made to the satisfaction of the Central Bank of Nigeria. In compliance with this stipulation, CBN bank examiners are required to classify bank loan assets into sub-standard, doubtful and lost. A provision of 100 per cent is recommended for lost loan assets and 50 per cent provision for doubtful ones. As of now, there is no provision yet for sub-standard loan assets.
Interest Rate Risk
This is a loss (to a bank) arising from changes in the level of interest rates. For example, if a bank raises funds in the inter -bank market at 35 per cent for instance and before the bank can place the funds, the market rate of interest has fallen such that the bank is unable to obtain at least 35 per cent on the placement, then a loss has been sustained. Interest rate risks are common during periods of tight money of the type currently being experienced by Nigerian bankers. Until the current liquidity squeeze, interest rate risk was never a serious risk for Nigerian bankers.
Purchasing Power (Inflation) Risk
Purchasing power, or inflation risk, arises from changes in the price level. Such unanticipated changes have the effect of eroding the purchasing power of financial securities or assets, thus resulting in a Loss to a bank. For example, a bank holds two-years Treasury Certificates valued at Nl0 million. At the time the certificates were bought, inflation was at 10 per cent per annum. By the time the certificates matured inflation, rose to 30 per cent. The real value of the NI0 million received plus the interest would certainly be less than the nominal value of the receipts. The difference between the real value (inflation adjusted amount) and the nominal amount, represents the loss due to purchasing power risk. This risk is one of the greatest risks facing the nation now due to rapid changes in the price level.
Bank Liquidity Risk
This is a risk of loss to a bank arising from the bank not having adequate funds to meet deposit withdrawals and Loan demands. The risk is a very serious one since it strikes at the credibility and confidence reposed in the bank. A liquidity risk can precipitate a run on a bank. Once there is a run, there is a good likelihood that the bank would be insolvent since no bank can withstand a sustained run on its deposits.
The above risks are inherent in one form or the other in a banking system. It is therefore the duty of bank management to attempt to minimise these risks and in effect, losses arising from them.
Liquidity management according to Johnson and Johnson (1989) entails the construction of assets in such a way that outflow of funds can be accommodated without making an understanding adjustment in liability. It involves a skilled treatment of liquidity to support the banks’ assets or assets growth, as well as maintaining a certain level of fluidity in the assets in order to meet potential demand for liquidity.
Every banking institution has or should have a corporate goal. The goal may be maximising profits for the shareholders or maximising their investments or total wealth in the bank. Whatever the objective, there is inherently some kind of conflict between the objective and the need to maintain adequate liquidity. We want to attempt a brief discussion of this conflict.
Liquidity Versus Profitability
Finance theory argues that there is a positive linear relationship between risk and return. That is, saying that the higher. the risk, the higher will be the reward and conversely. In the context of liquidity, the higher the liquidity position of a bank, the less risky is the bank. Little risk as we found above is rewarded with a little return. In other words, high bank liquidity implies little risk which translates into low profitability.
The table below explicitly analyses the components of banks ‘liquid assets and the returns on them.Liquid Assets            Assessment of the Nature of                         Return
Vault Cash            no return
Balances with Central Bank    no return
Net Inter-bank Balance        negative/low return
Net Money at Call        negative/low return
Treasury Bills            low return
Treasury Certificates        low return
Bills Discounted        medium return
Eligible Development Stocks    medium return
Bankers’ Unit Funds        medium return
Certificates of Deposit        medium returnThe table shows that no liquid assets has been assessed as having high return. However, it” is high return that leads to high profits. The liquid assets generally have returns varying from “no return” to “medium return” because of their liquidity. That is the fact that the assets can easily be turned into cash. They are also easily marketable. We can now turn to the traditional measures of bank liquidity
Measures of Bank Liquidity
In the banking system, liquidity requires close monitoring because, as we have seen, inadequate liquidity will damage a bank’s reputation and excess liquidity will retard earnings. Therefore, in measuring liquidity, the qualities of an asset that enables it to be transformed with minimum delay into cash should be considered. Accordingly, the 1969 Banking Act as amended requires that the CBN shall from time to time stipulate minimum holdings of licensed banks’ cash reserves, liquid assets, special deposits and stabilisation securities. In this regard, each bank must ensure that its holdings of these items are not less than the amount prescribed by the CBN. The major liquidity measures maintained by Nigerian banks are as follows:
The Cash Reserve Ratio (CRR)
This is the minimum level of cash deposit expressed as a ratio of a bank’s demand deposit liability which a bank is expected to maintain at the CBN. The ratio can be computed as follows:
Cash Reserve Ratio    =    Cash Balances of the Bank
Demand Deposits
The cash balances are made up of vault cash and allowable cash balances with the CBN. For 1989, the following cash reserve balances were to be maintained by commercial banks depending on banks’ deposit liabilities:Bank Class        Total Deposit Liabilities    Ratio of Cash Deposit                             to Demand                                     Deposit (%)

A            NI billion or more          9.0

B            N500 million or more but      8.0
less than N1 billion

C            N100 million or more        7.0
but less than N500 million

D            Less than Nl00 million         6.0    The above table shows that the cash reserve ratio for 1969 varies from 6 to 9 per cent of banks’ demand deposits. It must be noted that these required reserves are first and foremost intended to ensure bank liquidity and secondly, it is useful as a monetary policy tool of the CBN. The monetary authority raises the ratio when it desires to curtail banks’ money creating ability and reduces the ratio when it desires to expand credit
The Liquidity Ratio (LR)
This is a ratio of a bank’s total liquid assets to total deposit liabilities measured as follows:
Total Liquid Assets
Liquidity Ratio        =             Total Deposit Liabilities
The liquid assets include: vault cash, balances with the CBN, net inter-bank balances, net money at call, treasury bill holdings, treasury certificates, bills discounted, eligible development treasury certificates, eligible development loan stocks, bankers’ unit funds and certificates of deposits. On the other hand, the total deposit liabilities are made up of demand, saving and time deposit liabilities of a bank
The liquidity ratio is used as a measure of a bank’s liquidity and is prescribed for banks every year by the CBN. The ratio stands at 30 per cent for commercial banks and 22.5 per cent for merchant banks. When the CBN desired to tighten bank credit about the second quarter of 1989, it raised the ratios from 27.5 and 20 per cent, respectively, to their current levels.
The Loan-to-Deposit Ratio
This is another measure of bank liquidity. The measure is based on the fact that loans and advances are the most illiquid of a bank’s earning assets, such that a high loans-to-deposit ratio implies low liquidity position and conversely. The ratio is computed as follows:
Loan-to-Deposit Ratio  =    Total Loans and Advances
Total Deposit

This ratio has the limitation of not saying anything about either the quality of the loans and advances nor their maturities. At the moment, the ratio of loans and advances to deposits regarded as prudent in Nigeria is 70 per cent. A ratio in excess of this would indicate that the bank is over-trading and may not be able to meet the day-to-day cash requirements of depositors.
Limitation of Liquidity Ratios
In spite of the appeal in the foregoing ratios, it is important to note that the ratios are not adequate as a gauge of the true liquidity position of a bank. This is so because ratios are computed at a point in time, say as at the end of the month. In effect, the computation is based on a “stock” concept. Liquidity assessed on the basis of a flow of liquid resources over a period of time (flow concept) would be more meaningful. Unfortunately, a ratio is computed using the latter concept.
It is important to note the shortcomings in the use of ratios to assess a bank’s liquidity. Ratios are only meaningful when accounting practices and ratios can be window-dressed. However, if properly used, ratios can give signals of illiquidity which would require further investigation.
Liquidity Management in Practice
In addition to ratio analysis, in practice, banks attempt to determine what adequate liquidity is for them by estimating likely variations in deposits and loans demand. The banks make sure that they maintain adequate stock of cash to meet daily cash demand. Unfortunately, the forecasts of deposits and loans demand are rarely performed scientifically: rules of thumb and experience are employed.
Practical liquidity management in Nigeria also emphasises the willingness and ability to borrow funds on a short-term basis. This accounts for the thriving inter-bank market in spite of high cost of funds in the market.
Rediscounting of eligible short-term financial claims with the Central Bank is yet another avenue to generate liquidity. Such instruments as treasury bills and treasury certificates for example can be rediscounted with the CBN if a bank experiences a temporary liquidity squeeze.
Government Policy Measures on Bank Liquidity
In recognition of the vital role the banking sector is expected to play in the economic activities of a nation, governments all over the world introduce from time-to-time, measures that affect banks’ liquidity. The Nigerian government is not an exception and it is therefore not surprising that government annually introduces monetary and fiscal policies which influence the liquidity position of our banks. The preoccupation of government in this matter has always been to ensure and promote safe and sound banking practices in the country. Government policy measures on interest rates, cash reserve requirement, liquidity ratio, operation of government institutions’ accounts, taxation and government borrowings, among others, have far-reaching effects on the liquidity position of banks. We shall examine some of these measures.
Interest Rate Policies
Until the direct control over interest rates by the CBN was abolished on July 31, 1987, minimum rates were usually set for savings and time deposits plus maximum lending rates. Also, the CBN would set a minimum rediscount rate at which the monetary authority would rediscount approved short-term financial assets or extend temporary accommodation to banks. These minimum and maximum interest rates were usually set at the beginning of the year subject to review in the course of the year. However, since the deregulation of interest rates, the CBN has been content with setting only the minimum rediscount rate while the other rates would be determined by the demand for and the supply of loanable funds.
Prevailing interest rate (government-or market-determined) have impacts on a bank’s liquidity position. High rates of interest on saving and time deposits are likely to attract such deposits to the bank. The bank would be encouraged to lend for longer periods and this may adversely affect the bank’s liquidity position. In a situation where there is a reverse yield curve (short term interest rates being higher than long-term rates) as is currently the case, banks are likely to be very active in inter-bank markets either as lenders or borrowers. Such an avenue for borrowing should enhance bank liquidity if cost considerations are ignored. Some banks may even find it on the inter- bank market if short-term rates are significantly higher than long-term rates.
Cash Reserve and Liquidity Ratio Policies
These ratios, required to be maintained by banks, are primarily intended to ensure that banks are liquid. It can be argued that their deployment as monetary policy tools is secondary to ensuring liquidity.
Cash reserve ratio for instance ensures that banks are liquid enough to meet demand deposit withdrawals. The liquidity ratio on the other hand assures that banks are liquid enough to meet total deposit withdrawals not precipitated by a run.
Bank Credit Policies
Government policies implemented through the CBN ensure that bank’s total credit grows at a required rate every year. The policies also specify the growth rates of banks’ credit to the private sector and to government.
When a bank buys government treasury bills and treasury certificates, such a bank is indirectly lending to government. These instruments held by a bank rate counted by the CBN as part of banks’ liquid assets. In this sense, one can say that banks’ credit policies by government influence banks’ liquidity
Government Taxation
The tax policies of government have impacts on bank liquidity. For example, a high profit tax rate denies a bank an opportunity to plough back a high proportion of its net earnings. Reserve funds of this nature strengthen a bank’s capitalisation and ensures long-run liquidity improvement for the bank. Also, the current withholding taxes on interest on banks’ deposits can have the effect of discouraging some customers at the margin from holding deposits which attract the withholding taxes. However, such deposit are needed by banks as they are often the banks’ core deposits which enhance the long-term liquidity position of the bank.
The Role of the NDIC in Banks’ Liquidity
The Nigeria Deposit Insurance Corporation (NDIC) as another regulatory body of licensed banks, has a cardinal responsibility to ensure safe and sound banking practice in Nigeria. A liquidity problem provides a signal of a bank’s potential insolvency if the liquidity problem is not adequately managed. The discernable functions of the NDIC in a bank’s liquidity problem can be grouped into preventive and curative.
Preventive Measures
In order to prevent a liquidity problem in the banking system as a whole, the NDIC periodically evaluates the funds management strategies of each insured bank. The process of evaluation involves a thorough appraisal of the bank’s quality of management, capital nature of assets and liabilities, especially the quality of loans and advances. The loans and advances are usually classified into sub-standard, doubtful and lost The NDIC bank examiner would ensure that adequate provision has been made for these categories of loans and advances. In addition, the NDIC analyses the monthly statements of banks’ assets and liabilities to ensure that the banks comply with CBN guidelines on liquidity.
It is obvious that the preventive measures to ensure bank liquidity are mainly through regular on-site and off-site examinations. The NDIC examiners are guided by the following terms of reference in the course of their examinations:
(i) to assess the management of the banks’ assets and liabilities;
(ii) to assess if the bank has adequate plans for liquidity needs and the bank’s ability to
meet anticipated liquidity demands;
(iii) to assess if the parameter for the bank’s rate-sensitivity position is reasonable and if
the bank is operating within the prescribed parameters;
(iv) to assess the adequacy of the bank’s internal management report; and
(v) to recommend and ensure that corrective actions are initiated where funds management policies, practices or procedures are inadequate.
Through the analysis of the banks’ returns and on-the-spot assessment, the adequacy of a bank’s liquidity position is determined.

This determination of a bank’s liquidity position is usually based on the examiner’s analysis of the following:
(i) compliance with CBN guidelines on liquidity;
(ii) asset liability mix and trends;
(iii) dependence on market rate funds; and
(iv) trends in interest margins and stability of interest margins under varying economic
The examiners will determine through these variables whether or not adequate funds are available to meet anticipated or potential cash needs of the bank. These findings will aid the NDIC management in determining and advising the bank accordingly on the options for reducing funding needs or attracting additional funds.
The Corporation may recommend one or more of the following options
depending on the liquidity needs of the bank:
(i) disposal of liquid assets;
(ii) increased use of short-term assets;
(iii) decreased holdings of long-term assets;
(iv) increased long-term liabilities;
(v) increased capital funds; and
(vi) improved workable management information system.
In addition to the above, the NDIC assists the CBN in formulating policies to ensure safe and sound banking in the country.
Curative Measures
The curative aspect of NDIC’s involvement in the liquidity management of banks entails helping banks out of liquidity problems. The NDIC can render any or all of the following as assistance to a bank with liquidity problems as contained in the NDIC Decree of 1988:
(i) grant loans to the insured bank;
(ii) give guarantee for a loan taken by the insured bank;
(iii) accept an accommodation bill with interest for a period not exceeding 90 days maturity exclusive of days of grace and subject to renewals of not more than four times; and
(iv) subject to the approval of the Minister of Finance and on the recommendation of the CBN, take over the management of the bank until its financial position has substantially improved or direct specific changes to be made in the management of the bank within such a time as the Corporation may specify.
It is in keeping with these functions as contained in the NDIC Decree that the NDIC is currently accepting accommodation bills drawn by banks on the Corporation to enable the banks discount the bills with the CBN. The proceeds of the bills are used to clear the banks’ overdrawn positions with the CBN.
Summary and Conclusion
It has been noted that maintaining liquidity and profitability are the two major preoccupations of banks. Liquidity and profitability are in themselves conflicting goals in the sense that too high liquidity contains profitability but allows a bank to meet cash demands by depositors. Inadequate liquidity, on the other hand, can precipitate a run on a bank which would endanger, not only profitability, but the very existence of the bank. Herein lies the need for liquidity management.
Monetary authorities are understandably concerned about banks’ liquidity. As a result, the Central Bank of Nigeria sets ,targets every year for banks’ cash reserve and liquidity ratios. Banks are mandatorily required to maintain the ratios. Banks also attempt to make forecasts of depositors’ cash needs.
Such forecasts are used to plan for the bank’s liquidity. Recently, Nigerian banks have had to rely extensively on inter-bank markets and the CBN’s discount window to meet their liquidity requirements following the liquidity squeeze in the economy. We have also observed that government policies affect banks’ liquidity positions through interest rate policies, mandatory reserve ratios, bank credit and taxation policies.
The Nigeria Deposit Insurance Corporation has a statutory responsibility of preventing and curing bank illiquidity. The preventive measures taken by the Corporation include appraising periodically, the quality of banks’ management, capital, loans and advances plus ensuring that banks comply with mandatory liquidity ratios. Where deficiencies are noted in these variables, the NDIC offers advice on the options that are available to the bank for reducing cash requirements or attracting additional funds.
The curative responsibility of the NDIC has to do with helping banks already in liquidity problems. The NDIC Decree grants the Corporation powers to grant loans to such banks, to give guarantees on loans taken by the banks from other agencies, to accept accommodation bills from the banks and to take over the management of the banks until the banks’ financial positions have improved substantially.
In conclusion, it should be observed that the NDIC has come at a time Nigerian banks have the most need for the Corporation. Further, the existing liquidity management in our banks with banks’ primary reliance on volatile inter-bank funds and CBN’s discount window for enhanced liquidity leaves much to be desired. In this connection, it is recommended that banks should put greater efforts at sourcing more stable, long-term funds. Banks should, in addition, adopt scientific measures in liquidity planning instead of the current ad hoc approaches used by many banks.