A STUDY ON LIQUIDITY ANALYSIS OF NEPAL BANK LTD

Submitted by
Asmita Shrestha
Birgunj Public College
TU Redg. No. : - 7-2-439-1-2018

Submitted to

Faculty of Management
Tribhuvan University, Kathmandu
For the partial fulfillment of the Degree of
Bachelor in Business Studies (B.B.S 4th year)

Birgunj, Madhesh Province,Nepal

 RECOMMENDATION

This is to certify that Ms. Asmita Shrestha has prepared the thesis entitled “A
STUDY ON LIQUIDITY ANALYSIS OF NEPAL BANK LTD” under our
supervision.

This thesis has been prepared in the form as required by the faculty of
management for the partial fulfillment of the Degree of Bachelor in Business
Studies (B.B.S).

It is forwarded for examination. We recommended this thesis for approval and

acceptance.

…………………………..
Mrs.
Thesis Supervisor
 VIVA-VOICE SHEET

We have conducted the viva-voice examination of the thesis presented by

Asmita Shrestha
Entitled

A STUDY ON LIQUIDITY ANALYSIS OF NEPAL BANK LTD.

and found the thesis to be the original work of the student written according to the
prescribed format. We recommend the thesis to be accepted as partial fulfillment for
Bachelor Degree in Business Studies (B.B.S)

Viva-Voice Committee

Head of the Research Department ………………………

Member (Thesis Supervisor) ………………………

Member (External Expert) ………………………

 DECLERATION
I hereby declare that the project report on the thesis entitled “A STUDY ON
LIQUIDITY ANALYSIS OF NEPAL BANK LTD” Submitted to Faculty of
Management, Birgunj Public College is my original work in the form of partial
fulfillment of requirement of Bachelor in Business Studies (BBS) under the
guidance of Mrs.

…………………………………

ACKNOWLEDGEMENT

It is my great privilege to complete this thesis under the supervision of Mrs.

……………. Thesis Supervisor of Birgunj Public College, for her intellectual
direction, supervision and inspiration during the preparation of this thesis. It
would not have been possible for me to complete this work without her
guidance.

I would like to express many thanks to Mr. Subha Ratna Shakya and Ms. Sabina
Shakya, staffs of Nepal Bank Limited, Professors and Lecturers of Birgunj
Public College. All my colleagues, staff of Library and Administration of
Birgunj Public College and Central Library of
T.U. who helped me directly and indirectly in this dissertation work

Similarly I would like to express my sincere gratitude to all my family members

and friends who inspired me in many ways to cope with during the entire period
of study.
 CHAPTER I
INTRODUCTION
1.1 Background of the Study

A day-to-day management of a firm’s short-term assets and liabilities plays an important

role in the success of the firm. Firms with glowing long-term prospects and healthy
bottom lines do not remain solvent without good liquidity management. Hence, despite
maximization of shareholder wealth still remaining the ultimate objective of any firm,
preserving the liquidity of a firm is equally an important objective and as such a firm
should balance among the different interest objectives. Increasing profits at the cost of
liquidity can bring serious problems to the firm and a tradeoff between these two
objectives of the firms needs to be struck. If a firm does not care about profit, it will not
survive for a longer period while on the other hand if it does not care about liquidity, it
may face the problem of insolvency or bankruptcy. For these reasons, therefore, liquidity
management should be given proper consideration and will ultimately affect the
profitability of the firm.

A firm can have a large sale level through adopting a generous credit policy and thus
extending the cash cycle though the action may increase the level of profitability.
However, the traditional view of the relationship between a firms liquidity level is such
that, all other factors remaining constant, the longer cash conversion cycle hurts the
profitability of the firm (Deloof, 2003). This therefore requires that the level of working
capital that a firm maintains need to be kept at an optimum point that will maximize the
profits. Liquidity and profitability are crucial elements that organization keeps in mind
while assessing their financial position. These are considered one of the most important
issues in corporate finance and are essential for the survival of any bank. Short term
survival of a bank is dependent on its liquidity while, its long term growth and survival
depends on its profitability. The basic function of commercial bank is to receive deposits
and to lend money. At the same time, it has to maintain adequate liquidity. If case of
negligence, the bank may face risk. At the same time, increased liquidity would reduce
the profits. So the banks must maintain a balance between the profitability and liquidity.

Every stakeholder has its interest in the liquidity position of a bank. In this research we
have analyzed how a bank’s liquidity affects its profitability. Profitability is actually the
return which a company earns from its operations. Basic purpose of a business is to earn
profits and so does banks. Banks profit is calculated as the difference between the interest
it charges on the loans it grants to its customers and the interest which it pays to its
account holders. For determining the impact of liquidity on profitability of the banks,
certain ratios are considered that would be further discussed in the methodology section.

Several studies has been undertaken to inquire the major determinants of a bank’s
profitability and liquidity has always remained one of the major determinants. Several
studies has been undertaken to inquire the major determinants of a bank’s profitability
and liquidity has always remained one of the major determinants. (Bourke, 1989) found a
positive relationship among liquid assets and profitability of about 90 banks in Europe,
North America and Australia for the period of 1972- 1981.In most economies developed
and developing, banks are the most important financial institutions. The banking sector is
an important element in any economy as it plays the roles of satisfying the needs of
investors with new financial instruments that offer a wider range of opportunities for risk
management and transfer of resources, lowering transactions costs or increasing liquidity
by creating financial instruments such as loans and also works as the operator of the
payment system. Other roles played by the banking sector include the fundamental role in
financial intermediation by mobilizing deposits from members of the public and
employing such deposits by way of loans and investments. The significance of the
banking sector underlines the need for stability in the sector that is vulnerable to financial
distortions. Key drivers of stability for any commercial entity are profitability and
liquidity.

Credit is regarded as the heart of the commercial banks in the sense that; it covers the
main part of the investment; the most of the investment activities based on credit; it is the
main factor of creating profitability. It is the main source of creating profitability: it
determines the profitability. It’s effect the overall economy of the country. In today’s
context, it also affects on national economy to some extent. If the bank provides credit to
retailer, it will make the customer status similarly, it provides to trade and industry of the
Government. Will get tax from then and help to increase the national economy. It is the
security against depositors. It is proved from very beginning that credit is the
shareholders wealth maximization derivative. However, other factors can also affect
profitability and wealth maximization but the most effective factor is regarded as credit.
It is the most challenging job because it is backbone in commercial banks. Thus, effective
management of credit should seriously be considered.

Credit management refers to fund and working capital management. However, most
people have some miss concepts. They only consider heredity management is a short-
term process. In fact, if it relates to working capital, it may be right. However, if it relates
to fund management, it can be a long-term basis. We may imagine asset valuation for
credit evaluation, i.e. a credit management step, refer to fixed assets usually. Value of
fixed assets will change over its life. In other words, your credit evaluation will adjust all
the time. Credit Management is the process of mitigating the risk involved in granting the
credit. It is a key to successfully utilize our credit by minimizing our risks and losses.
Credit is regarded as the most income generating assets especially in commercial banks.

A credit facility is said to be performing if payment of both principal and interest are up
to date in accordance with agreed repayment terms. The non- performing loans (NPL)
represent credits which the banks perceive as possible loss of funds due to loan default.
They are further classified into substandard, doubtful or lost. Bank credit in lost category
hinders bank from achieving their set targets (Kolapo, Ayen, & Oke, 2012).

The wave of financial globalization that started in the 1980s transformed financial
markets and institutions around the world. As a result of this trend of financial
integration, global banks increased their footprint within their domestic markets and
across both emerging and advanced economies. In this process, banks developed different
business models to manage the funds raised from external sources. One of those business
models operates by centrally managing liquidity within the banking organization. The
central office in this type of banking organization allocates resources across its branches
depending on the objectives of the officers of the bank. Thus, external liquidity raised
throughout the bank is moved internally across offices in different countries or regions
within a country (Campello, 2002)
Liquidity means allocation of funds in close relation to their respective sources. Liquidity
is the status and part of the assets which can be used to meet the obligation in the
commercial banks. Liquidity can be viewed in terms of liquidity stored in the balance
sheet and in terms of liquidity available through purchased funds. Liquidity is the ability
of a bank to pay cash to depositors on demand. It is the arrangement and the allocation of
funds in such a way that can be drawn immediately without any loss of principle. At
present, there is no secured investment opportunity for the Nepalese commercial banks.
The banks are facing the problem of vague liquidity in term of monetary firm.The idle
money does not make any return. Therefore, the high liquidity may cause of low
profitability and inefficient performance of the overall Banking sector. It may cause
failure of banking performance in long term (Pandey, 2000).

Liquidity is a financial term that means the amount of capital that is available for
investment. Today most of this capital is credit, not cash. Bank Liquidity simply means
the ability of the bank to maintain sufficient funds to pay for its maturing obligations. It is
the bank’s ability to immediately meet cash, cheques, other withdrawals obligations and
legitimate new loan demand while abiding by existing reserve requirements. Nwaezeaku
(2006) defined liquidity as the degree of convertibility to cash or these with which any
asset can be converted to cash (sold at a fair market price).

Liquidity management therefore involves the strategic supply or withdrawal from the
market or circulation the amount of liquidity consistent with a desired level of short- term
reserve money without distorting the profit making ability and operations of the bank. It
relies on the daily assessment of the liquidity conditions in the banking system, so as to
determine its liquidity needs and thus the volume of liquidity to allot or withdraw from
the market. The liquidity needs of the banking system are usually defined by the sum of
reserve requirements imposed on banks by a monetary authority (CBN, 2012).

The liquidity is a vital factor in business operations. For the very survival of business, the
firm should have requisite degree of liquidity. It should be neither excessive nor
inadequate. Excessive liquidity means accumulation of ideal funds. Which may lead to
lower profitability, increase speculation, and unjustified extension, extension of liberal
credit terms, liberal dividend policy etc; whereas inadequate liquidity result in
interruptions of business operations. A proper balance between these two extreme
situations therefore should be maintained for efficient operation of business through skill
full liquidity management. The need of efficient liquidity management corporate sector
has become greater in recent years.

The need for liquidity of current assets could not be over emphasized. The efficient
management of liquidity is integrated part of overall finance management and has a
bearing on the objective of the consolidation of short-terms solvency position to achieve
this. It is necessary to generate sufficient liquid fund. The extent to which liquidity can be
gained will naturally depend upon the magnitude of the sales. The efficiency of collection
department the lowest period of operating cycle etc. a successful collection programmer
is in other words, necessary for maintaining liquidity by any business enterprises. Those
sales don't convert into cash is instantly remain a time lag between the sales of goods and
receipt of cash.

Many people do not realize just how dramatically a single bad mark on your credit can
alter your ability to obtain good interest rates. The impact is even more dramatic the more
negative items appear on your credit file. Someone with bad credit has a very difficult
time obtaining credit of any form, including a job at times. Keeping your credit file clean
is often one of the only ways to ensure that you will be able to obtain a good job, as well
as qualify for the lowest interest possible in order to save money while still purchasing
the things you need in life.

1.2 Introduction of Bank

Bank is a licensed financial institution to deal with money i.e. to receive deposits from
the general public, make loans and investing in securities. Bank act as an intermediary in
financial transactions and provide financial services to its customer, such as wealth
management, Currency Exchange and safe deposit boxes. The bank generates profits
from the difference in the interest rates charged and paid (Business Dictionary, n.d.).
A Bank is a good mediator between depositors and loan takers. It is an organization
whose primary functions are concentrated with accumulation of idle money from general
public and make loan to individuals, traders industries and business houses for
expenditure.

When there were no banks people used to consider temples to be safest refuge; it is a
solid building, constantly attended, with a sacred character which itself may deter thieves.
In Egypt and Mesopotamia gold was deposited in temples for safe-keeping. “The Bank of
Venice” is the first bank which was established in Venice Italy in 1157 A.D. In 1401 and
1408 A.D. Bank of Genoa was establish, to finance. In 1609 A.D. “Bank of Amsterdam”
and “Bank of England” was established in 1940 it played the vital role for the
development of modern banking system. After its establishment, banks spread all over
the world (History World, n.d.).

In the context of Nepal, the first commercial bank in Nepal, Nepal Bank Ltd (NBL), was
established in the year 1994 B.S. This is a major milestone in the history of Nepal as the
country entered into official financial system. After the nineteen year of establishment of
NBL, the Nepal Rastra Bank (NRB) was established in the year 2013 B.S. Rastriya
Banijya and Agricultural Development Bank Ltd. were established in the year 2022 and
2024 B.S. respectively. In the year 2041 BS, the first privately owned commercial bank
of Nepal, Nabil Bank ltd. was established. Seven more commercial banks were added in a
decade after 2041 B.S. (Sharesansar, n.d.)
1.3 Bank Profile

Nepal Bank Limited (NBL) , the first bank of Nepal proudly holds the glory of marking
the formal beginning of banking system in Nepal. Nepal Bank Limited was established as
FIRST bank of Nepal on Kartik 30, 1994 (November 15, 1937 A.D.) under Nepal Bank
Act 1937. The bank was established with an authorized capital of Rs.10 million, issued
capital of Rs.2.5 million and paid up capital of Rs.0.842 million. The share held by
government and private sector was 60% and 40% respectively.

Glance of NBL in 1994 B.S.

Paid up Capital Rs.0.842 million

No. of Shareholders 10

Total Deposit Rs.1.7 million

Total Loan Rs.1.98 million

No. of Employees 12

Noteablly, Nepal Bank Limited was inaugurated by King Tribhuvan with supportive
vision of Prime Minister Juddha Shumsher Jung Bahadur Rana to institutionalize formal
banking system in Nepal. Before the establishment of NBL, all monetary transactions
were carried out by private dealers and trading centers. It was the time when there was no
trust for such formal banking system. This reflected in under subscription of shares
(OnlyRs.0.842 million could be raised out of floated capital of Rs.2.5 million). Raising
deposit and mobilizing the collected deposit was even more difficult.

Absence of any bank in Nepal was hampering the economic progress of the country. This
was taken into consideration by Nepal Bank Limited with key focus on overcoming such
economic hamper and difficulties of general public. This was initiated by providing
banking services to people removing their inconvenience. This objective got better and
bigger with the time. Nepal Bank Limited has so far adopted according to the
technological changes, national economic welfare, customer preferences in services,
market competition and global financial scenarios to become a leading, glorious and
highly reputed bank of Nepal.
CORPORATE VISION
To be the most preferred bank of the Nation with complete banking solutions.
MISSION STATEMENT
Nepal Bank collaborates with its customers while designing, developing, and delivering
banking solutions to satisfy the interest of all stakeholders by efficiently leveraging
cutting-edge technology. The bank endeavors to be ethical in product offering, responsive
in operation, and trustworthy in ensuring security to protect its own and customers'
interests.

GOAL
In line with the Vision and Mission Statements, the bank's goal is "To Achieve secured
and sustainable business growth to attain larger market share" through enhancing
Operational Efficiency and Customer Service, Increasing HR Productivity, and Risk
Management System.

Capital Structure of Nepal Bank Limited.

Authorized Capital 15,000,000,000
Paid Up Capital 100% 12,636,758,624
1 Nepal Government 51% 6,444,746,896
2 Public Shareholder 49% 6,192,011,728

1.4. Products and Service Offered by Nepal Bank Ltd

 NRN Saving Deposit Account

You can save your love to your land with “NRN Saving Deposit Account”. This is a
product designed and developed to meet the saving need of NRN (Non-Resident
Nepalese) all over the world to send and save their earnings to their loved land.

 NBL Pioneer Saving Deposit Account

Being a pioneer bank of the country, we hereby offer you " NBL Pioneer Saving Deposit
Account" with pioneer banking and insurance facilities. Save with us for secure financial
future and personal welfare.
  NRN Fixed Deposit Account
No matter where you are, you still love your nation and can contribute towards your own
and the growth of the nation. For this, you can deposit your valuable money in our
“NRN Fixed Deposit Account”. This account has been designed and developed for NRN
(Non-Resident Nepalese) residing outside Nepal wanting their earnings to be safe with
the best return in their land of love.

 Credit Card
NBL Visa Credit Card provides the service of plastic card with credit facility to the
individual customers. This product is one of the value-added services to the customers of
Nepal Bank Limited.

Credit card business stands on the principle of "buy now- pay later". It allows customers
to buy goods and services based on the holder’s promise to pay for them later. Normally,
it is issued based on the credibility of the individual applicants.

 Sahayatri Bachat khata

If you care each other and want to share happiness forever, saving and financial planning
is a key part of it. So, let us be there for your financial future together with our “Sahayatri
Bachat Khata”.

 Shubha Gyan Bachat Khata

Being a student is not just about learning for better tomorrow, it is also about saving for
secure tomorrow. Thus, so as to cater this need of students and craft their better financial
future, we present our feature loaded “Shubha Gyan Bachat Khata”. Any student
Studying at any level can open this account and enjoy the best offers made. This account
can be opened by visiting any of our branches or online from our website.

 Internet Banking
Why stand in line when you can be online? Nepal Bank offers convenient banking
facilities through the Internet so its valued customers can save their time and money.
Nepal bank online banking features many of the traditional banking activities which
previously could only be done through the counter.

 Safe Deposit Locker

"The Best Protection For your most Important Valuables"
Your valuables are safely stored in another location other than your home or
business...the SAFEST PROTECTION from fire and theft. Nepal Bank Limited offer you
safe deposit vault to store items that would cause you to say "if I lose this, I'm in deep
trouble." This means important papers like insurance policies, family records such as
birth certificates, deeds, titles, mortgages, leases, contracts, bonds, certificates of deposit.

Other items include jewels, medals, rare stamps and negatives for important photos in
case of fire or theft.

 QR Code Payment
As a Cashless system of making payment, Nepal Bank offers an alternative to the
traditional systems, a payment via QR Code scanning through Mobile Banking QR
payment systems have the advantage of enabling transactions to be processed quickly and
more cheaply and also offer a much more convenient method of effecting settlement of
transactions.

QR code (Quick Response) is a black and white dotted digital image which holds certain
information on it and only smart phone's camera can scan the details. Nepal Bank has
introduced QR payment technology through Mobile banking channel for the first time in
Nepal. In this technology, simply customer makes payment through mobile by scanning
QR code at the merchant.
QR Code Payment option is available in Nepal Bank Mobile banking apps and is
accepted by more than 50k merchant outlets in Nepal.

Following are the steps for QR code scan and payment on Merchant Outlets:

Customer opens bank's Mobile Banking application. Without login into the application,
Customer Scrolls on right side of the landing page. The "Scan to Pay on Merchant
Outlets" screen appears which is used to scan the QR code displayed on the merchant
side.

Also, by login into the Mobile banking application, Customer Needs to click on "Scan 2
Pay" option which leads to "Scan to Pay on Merchant Outlets" screen. The QR Code
which customer scans comes into 2 ways; either through the physical QR code standee
that is placed in the merchant side or through Merchant Mobile apps which merchant
generates QR code in their mobile.
  Nari Samman Bachat Khata
This account is designed on the honor of Nepalese women. This is a respect for value of
women making saving and future financial decisions of herself and her family.

 Salary Saving Account

Staff salary account is designed to all the salaried employees working in any institution.
This account is the banking channel of receiving monthly salary of such staffs.

1.5 Statement of the Problem

Liquidity management is the essence of commercial banking; consequently the

formulation and implementation of second lending policies are among the most important
responsibilities of directors and management. Well-conceived liquidity management
policies and careful lending practices are essential if a bank is to perform its credit.
Liquidity management effects on the company’s profitability, so it is one of the crucial
decisions for the commercial banks.

Holding more liquid assets diminishes a commercial bank’s profit and hinders the
investment prospect of the bank, which could lead to growth and expansion. However, if
it wishes to maximize profit, the commercial bank will have to reduce the level of liquid
assets it holds on the balance sheet. Holding too much illiquid asset will expose the
commercial bank to liquidity risk and huge interest charges in an even of fire sales (Casu,
et al 2006). Eljelly (2004) opines that firms with high liquidity have majority portion of
their investments in short term assets, which have lower return than the long term assets.
Dernberg (1985) observed that in managing their portfolios, the commercial banks have
two main aims that may conflict; maintenance of stock of liquid assets in case their cash
is under pressure and the wish to earn high return on their assets in order to maximize
profits. Smith (1980) observed that excessive dependence on liquidity indicates the
accumulation of idle funds that don’t fetch any profits for the firm. On the other hand,
insufficient liquidity might damage the firm’s goodwill, deteriorate firm’s credit
standings and that might lead to forced liquidation of firm’s assets. Wahiu (1999) did a
study to establish the determinants of liquidity of commercial banks in Kenya. The study
involved all the commercial banks operating in Kenya during the period 1989 to1998. He
observed that one of the two most important requirements of liquidity is profitability. In
the modern and current liberalization of banks and financial institution in Nepal many
difficulties and complexities also have been emerging along with increasing demand and
supply of lending (liquidity management). In other word, some time high liquidity
condition affect to the credit and performance of the banks that due to ineffective
management of high liquidity by converting to lending in productive sectors with in time.
The increasing situation of non-performing loan is also badly affecting to the credit and
liquidity management of the banks.

The research questions to be raised for covering the issues of this study are as below:

 What is the Liquidity position of Nepal Bank Limited?

 What is the status profitability and risk position of Nepal Bank Limited?
 What is the trend and relation of the total deposit, investment and total loans of the
Nepal Bank Limited?

1.6 Objectives of the Study

The specific objective of the study is to examine the liquidity management & profitability
of Nepal Bank Limited along with this the other objectives are as follows:

 To identify the liquidity position of the Nepal Bank Limited.

 To identify the status of profitability and risk position of Nepal Bank Limited.
 To examine the trend and relations of total deposit, investments and total loans of
Nepal Bank Limited.

1.7 Significance of the Study

This study is very important from the point of view of liquidity management of the banks.
Because of the usefulness of recently updated data concerned with liquidity and
profitability evaluation to take decision on how can we go ahead in future to control if
any risks were emerged at present. The main strategy of every commercial bank is to
achieve the better creditability position, which has directly impacted the financial
performance of an organization. Beside it helps to build positive attitude and perceptions
non customer that helps to make the organizational successes in terms of better
transaction, better turnover and better profitability. The study helps for following concern
parties.

 This study will help to support for Nepal Bank Limited to forecast about credit and
liquidity.
 This study can be based for further research on concern topic.
 This study will help to formulated plan and policy for Nepal Bank Limited.
 This study will help for investor and creditor to identify the real financial position
that make considered whether expand additional money for further investment.
 This study can become the support documents to achieve academic degree.
 This study can be useful to concerned stakeholders (customer, suppliers,
businessmen, households, society, agent and government) to get information about
financial position of Nepal Bank Limited.

This study is based on specifically in case of joint-venture commercial banks in Nepal

and such study are rarely found in the Nepalese context. Moreover, this study seems to
provide roadmap for the formulation of different policies for the management regarding
liquidity management i.e lending viewing to maximize the return i.e profitability .

1.8 Limitations of the Study

The study focused to fulfill the partial requirement course of B.B.S of T.U. It has some
limitations. There have limited resources and it is difficult to explore researcher to find
out new aspect. Reliability of statistical tools used and lack of research experience are the
major limitation. The study is based on following limitations.

 This research is limited to liquidity management practice of Nepal Bank Limited.

 This study is limited on secondary data, which are used to analyze for result
interpretations, so the accuracy of the finding depends on the reliability of
available information.
 This study is limited on quantitative analysis which does not consider on
qualitative variable.
 It focuses on only Nepal Bank Limited Bank covering the period of five years
study. (I.e. 2016/17 to 2020/21)
 This research conducts limited study upon commercial banks which has left the
other part of financial institution such as development banks, finance companies,
micro finance companies and so on.
 Result of this study may differ according to different state of nature.

LITERATURE REVIEW
This chapter will includes the review of literature which includes review of books,
journals, bulletins and annual reports published by the banks and other related authorities,
review of related articles and studies and previous thesis as well.

2.1 Theoretical Review on Liquidity Management

The theories and liquidity management are outlined and explained in this section.

 Anticipated Income Theory

This theory holds that a bank’s liquidity can be managed through the proper phasing and
structuring of the loan commitments made by a bank to the customers. Here the liquidity
can be planned if the scheduled loan payments by a customer are based on the future of
the borrower. The doctrine of anticipated income, as formalized by Herbert V. Prochnow
in 1949, embodied these ideas and equated intrinsic soundness of term loans, which were
of growing importance, with appropriate repayment schedules adapted to the anticipated
income or cash flow of the borrower. The credit demands of business were well
accommodated under this system of banking policy, and the use of loan commitments
was freely pursued. Changing economic conditions, however, placed extra demands on
the banking system that resulted in a new approach to balance sheet management, and
businesses faced new financial challenges. Under this emerging state of affairs, bank loan
commitment policies would come to play a more important part in the credit process.
This theory has encouraged many commercial banks to adopt a ladder effects in
investment portfolio.

 Shiftability Theory

This theory posits that a bank’s liquidity is maintained if it holds assets that could be
shifted or sold to other lenders or investors for cash. This point of view contends that a
bank’s liquidity could be enhanced if it always has assets to sell and provided the Central
Bank and the discount Market stands ready to purchase the asset offered for discount.
Thus this theory recognizes and contends that shiftability, marketability or transferability
of a bank's assets is a basis for ensuring liquidity. This theory further contends that highly
marketable security held by a bank is an excellent source of liquidity. The Shiftability
theory liquidity replaced the commercial loan theory and was supplemented by the
doctrine of anticipated income. Formally developed by Harold G, Moulton in 1915, the
shiftability theory held that banks could most effectively protect themselves against
massive deposit withdrawals by holding, as a form of liquidity reserve, credit instruments
for which there existed a ready secondary market. Included in this liquidity reserve were
commercial paper, prime bankers’ acceptances and, most importantly as it turned out,
Treasury bills. Under normal conditions all these instruments met the tests of
marketability and, because of their short terms to maturity, capital certainty.

A major defect in the Shiftability theory was discovered similar to the one that led to the
abandonment of the commercial loan theory of credit, namely that in times of general
crisis the effectiveness of secondary reserve assets as a source of liquidity vanishes for
lack of a market (Casu et al 2006). The role of the central bank as lender of last resort
gained new prominence, and ultimately liquidity was perceived to rest outside the
banking system. Further- more, the soundness of the banking system came to be
identified more closely with the state of health of the rest of the economy, since business
conditions had a direct influence on the cash flows, and thus the re- payment capabilities,
of bank borrowers. The shiftability theory survived these realizations under a modified
form that included the idea of ultimate liquidity in bank loans resting with shiftability to
the Federal Reserve Banks. Under this institutional scheme, the liquidity concerns of
banks were partially returned to the loan portfolio, where maintenance of quality assets
that could meet the test of intrinsic soundness was paramount (Allen and Gale, 2004).

 Commercial Loan Theory

This theory has been subjected to various criticisms by Dodds (1982) and Nwankwo
(1992). From the various points of view, the major limitation is that the theory is
inconsistent with the demands of economic development especially for developing
countries since it excludes long term loans which are the engine of growth. The theory
also emphasizes the maturity structure of bank assets (loan and investments) and not
necessarily the marketability or the shiftability of the assets.

Adam Smith provided the first systematic exposition of the doctrine in his Wealth of
Nations (1776). Basically, it is a theory of asset management that emphasized liquidity;
the doctrine held that banks should restrict their earning assets to “real” bills of exchange
and short-term, self-liquidating advances for commercial purposes. In this way, it was
argued; individual banking institutions could maintain the liquidity necessary to meet the
requirements of deposit withdrawals on demand. Under a somewhat modified character
this basic doctrine came to be known in the U. S. as the commercial loan theory of credit.
The commercial loan theory of credit became obsolete both because of its conceptual
flaws and its impracticality. A critical underlying assumption of the theory held that
short-term commercial loans were desirable because they would be repaid with income
resulting from the commercial transaction financed by the loan. It was realized that this
assumption would certainly not hold during a general financial crisis even if bank loan
portfolios did conform to theoretical standards, for in most commercial transactions the
purchaser of goods sold by the original borrower had to depend to a significant extent on
bank credit. Without continued general credit availability, therefore, even short-term
loans backing transactions involving real goods would turn illiquid. Rigid adherence to
the orthodox doctrine was, furthermore, a practical impossibility if banks were to play a
role in the nation’s economic development (Casu, 2006). Moreover, the practice of
continually renewing short- term notes for the purpose of supporting long-term capital
projects proved unacceptable. The failure or inability of banks to tailor loan arrangements
to the specific conditions encountered with longer-term uses in fact contributed to the
demise of the practice.

2.2. Review of Related Research Studies

Fredrick (2012) analyzed the impact of liquidity management on the financial

performance of commercial banks in Kenya. The study has used CAMEL model as a
proxy for liquidity management. The author found that the strong impact of CAMEL
(credit risk components) on the financial performance of commercial banks.

Funso et. al. (2012) examined the effect of credit risk on the performance of commercial
banks in Nigeria over the period of 11 years (2000-2010). Panel model analysis was used
to estimate the determinants of the profit function. The results showed that the effect of
credit risk on bank performance measured by the Return on Assets of banks is cross-
sectional invariant. That is the effect is similar across banks in Nigeria, though the degree
to which individual banks are affected is not captured by the method of analysis
employed in the study. Based on our findings, it is recommended that banks in Nigeria
should enhance their capacity in credit analysis and loan administration while the
regulatory authority should pay more attention to banks’ compliance to relevant
provisions of the Bank and other Financial Institutions Act (1999) and prudential
guidelines

Hoseininassab et al. (2013) examined effects of risk parameters (credit, operational,

liquidity and market risk) on banking system efficiency (studying 15 top banks in Iran)
recognizing the importance of efficiency and risk as two fundamental important
categories in banking industry, seeks to review the effectiveness of two popular models:
parametric (SFA) method with economic basis and nonparametric (MEA) method with
mathematical optimization basis to evaluate bank efficiency and rank and select an
optimal model and also to identify the impact of credit, operational, market and liquidity
risks on banking system efficiency. The 15 banks were selected as statistical research
community over the last six years (2005-2011). Using average performance provided by
the above two methods, banks were ranked with Deap and Frontier software, and then to
examine the presence or absence of significant correlation between the rankings provided
by these two methods, the Pearson correlation coefficient was used. The results suggest
differences in the two methods with regard to performance evaluation and ranking of
banks, and show a relative superiority of SFA method, compared to MEA method. In
addition, to examine the impact of efficiency on risk, for the four studied risks based on
selected indicators, four models were estimated using econometric methods and the
ordinary least squares (OLS). The results showed that each of the studied risks and their
related indicator and their specific coefficient, significantly affect on efficiency.

Kumar & Yadav (2013) assessed on liquidity risk management in bank that Liquidity is a
bank’s capacity to fund increase in assets and meet both expected and unexpected cash
and collateral obligations at reasonable cost and without incurring unacceptable losses. In
the context of banking, liquidity, or the ability to fund increases in assets and meet
obligations as they come due, is critical to the ongoing viability of the banking institution.
Since there is a close association between liquidity and solvency of banks, sound liquidity
management reduces the probability of banks becoming insolvent, thus reducing the
possibilities of bankruptcies and bank runs. Ultimately, prudent liquidity management as
part of the overall risk management of the banking institutions ensures a healthy and
stable banking sector. Effective liquidity risk management helps ensure a bank’s ability
to meet its obligations as they fall due and reduces the probability of an adverse situation
developing. They examined the sound practices for the liquidity risk management in
banks. They went along with the suggestions of the Basel Committee and Reserve Bank
of India on management of liquidity risk. They explained the meaning of liquidity,
liquidity risk and liquidity risk management. It also discussed the process of building up
of a liquidity risk management system.

Kaitibi .B. et al (2018) assessed the impacts of efficient liquidity management on

profitability of commercial bank in Sierra Leone. For this purpose, the rokel commercial
bank was selected as case study. Relevant data were collected from five years financial
statements and annual reports of the bank. The analysis of the data was quantitatively as
well as qualitatively done using ratio analysis and charts. Results showed that
profitability of commercial banks in Sierra Leone is significantly influenced by the
efficiency of credit management. Noor .A. et al (2018) examined the impact of credit
risk management on financial performance of banks. This study was descriptive and
analytical natured based on secondary data sample of four different commercial bank.
The analysis of data was based on simple regression analysis of percentage of classified
loan on ROI, ROE, ROA and so on financial indicators. The study concluded that there is
significant relationship between the variables during short run.

Ibe O.S. (2013) investigated the impact of liquidity management on the profitability of
banks in Nigeria. The work is necessitated by the need to find solution to liquidity
management problem in Nigerian banking industry. Three banks were randomly selected
to represent the entire banking industry in Nigeria. The proxies for liquidity management
include cash and short term fund, bank balances and treasury bills and certificates, while
profit after tax was the proxy for profitability. Elliot Rothenberg Stock (ERS) stationary
test model was used to test the run association of the variables under study while
regression analysis was used to test the hypothesis. The result of this study has shown
that liquidity management is indeed a crucial problem in the Nigerian banking industry.
The study therefore recommends that banks should engage competent and qualified
personnel in order to ensure that right decisions are adopted especially with the optimal
level of liquidity and still maximize profit.

Abdullah & Jahan (2014) focused on two important issues of main stakeholders of bank
which are liquidity and profitability. The shareholders desire maximum profitability as a
return on their investment, while the depositors opt for a maximum liquidity as a
guarantee for safety and ability to pay their money on demand. Statistical significance of
liquidity on profitability can be a great factor for existing and potential stakeholders.
Therefore, this study had attempted to investigate the impact of liquidity and profitability
of the private commercial banks of CSE-30 in Bangladesh by focusing on certain ratios
over a period of five years. Five private commercial banks have been selected to
undertake the research. Profitability measures - ROA and ROE are dependent variables
and liquidity measures - Loan Deposit Ratio, Deposit Asset Ratio and Cash Deposit Ratio
are selected as independent variables. The research carried out simple regression analysis
to test the hypotheses. However, the null hypothesis is accepted in this study indicating
that there is no significant relationship between liquidity and profitability. Smail (2016)
referred the mounting importance of liquidity and profitability as a key concern in
today’s competitive business environment to generate funds internally.

Begum (2016) investigated the relationship between banks' liquidity and profitability and
the impact of liquidity on bank's profitability. The paper applies the ordinary least square
(OLS) method for the sample period from 1997 to 2014 to examine the impact of
liquidity on banks' profitability. The paper finds that the advance deposit ratio positively
impacts banks' profitability while profitability is defined as return on asset (ROA). Call
money rates, non performing loans (NPLs), and excess liquidity impact banks'
profitability in a negative fashion. The negative relationship between NPLs and ROA has
been a major concern for the policymakers in the banking industry of Bangladesh since
NPLs in the banking sector have increased during the last three years in the post 2011
period.

Ali et. al (2011)examined the profitability indicators of public and private commercial
banks of Pakistan explored in 2006-2009. The return on assets (ROA) and return on
equity (ROE) are used as profitability measures to determine the affect of bank-specific
and macroeconomic indicators on profitability. The descriptive, correlation and
regression analysis results are derived with the help of SPSS. The efficient asset
management and economic growth establish positive and significant relation with
profitability in both models (measured by ROA & ROE). The high credit risk and
capitalization lead to lower profitability measured by return on assets (ROA). The
operating efficiency tends to exhibit the higher profitability level as measured by return
on equity.

Olweny and Shipho (2011) determined and evaluate the effects of bank-specific factors;
Capital adequacy, Asset quality, liquidity, operational cost efficiency and income
diversification on the profitability of commercial banks in Kenya. The second objective
was to determine and evaluate the effects of market structure factors; foreign ownership
and market concentration, on the profitability of commercial banks in Kenya. This study
adopted an explanatory approach by using panel data research design to fulfill the above
objectives. Annual financial statements of 38 Kenyan commercial banks from 2002 to
2008 were obtained from the CBK and Banking Survey 2009. The data was analyzed
using multiple linear regressions method. The analysis showed that all the bank specific
factors had a statistically significant impact on profitability, while none of the market
factors had a significant impact. Based on the findings the study recommends policies
that would encourage revenue diversification, reduce operational costs, minimize credit
risk and encourage banks to minimize their liquidity holdings. Further research on factors
influencing the liquidity of commercials banks in the country could add value to the
profitability of banks and academic literature.

Aboila and Olausi (2014) investigated that the impacts of credit risk management on the
performance of commercial banks in Nigeria. Financial reports of seven commercial
banking firms were used to analyze for seven years (2005–2011). Panel regression model
was employed for the estimation of the model. In the model, return on equity (ROE) and
return on assets (ROA) were used as the performance indicators while non-performing
loans (NPL) and capital adequacy ratio (CAR) as credit risk management indicators. The
study revealed that credit risk management has a significant impact on the profitability of
commercial banks‟ in Nigeria. The results of the study revealed that there was a
significant relationship between credit management and bank profitability and there was
a significant relationship between bank liquidity and profitability among deposit money
banks in Nigeria.

Danjuma (2015) examined out a conceptual review of credit risk management and
customers’ satisfaction in Deposits Money Banks (DMBs) in Nigeria. It examined
concepts of credit and credit risk management based on credit and credit risk, credit
management and risk assessment tools The Credit Appraisal Process was also examined
from the corporate strategy and portfolio strategy perspectives. Conceptual issues relating
to customer satisfaction, consumer behavior and dimensions of customer satisfaction:
emotional, behavioral affective, cognitive and intention to repurchase were discussed.
The study proposes a conceptual framework for measuring link between credit risk
management and customer satisfaction in DMBs. Also, the framework proposes that
perceptions of customers about satisfaction can be determined based on their gender, age
and occupation.

Alshatti (2015) examined the effect of credit risk management on financial performance
of the Jordanian commercial banks during the period 2005-2013 using capital adequacy
ratio, credit interest/credit facilities ratio, provision for facilities loss/ net facilities ratio,
leverage ratio and non-performing loans/gross loans ratio as independent variables. The
dependent variables represent the profitability measured by ROA and ROE. The author
concludes that all the credit risk management indicators used in the study have significant
effect on the financial performance of the Jordanian commercial banks.
Onuko et al. (2015) investigated the effect of credit risk management on loan portfolio
quality of tier one commercial banks in Kenya. The study used loan pricing as the
independent variable while loan portfolio quality as the dependent variable. The quality
of the loan portfolio was measured by use of nonperforming assets (NPA).The study
employed descriptive research design. Five tier one commercial banks in Kenya were
analyzed. Financial reports for the five banks were analyzed between the years 2009-
2013. Data was collected through both primary and secondary methods. The findings
indicated loan pricing had significant positive effect on the level of NPA and it accounted
for 57.4% change in level of NPA. It is therefore recommended that financial institutions
charge affordable interest rates that will attract more creditors hence increasing their
revenue from interest earned. Further studies should carried out on other factors not
included in this study such as loan exposure limits.

Ugoani (2015) examined the relationship of poor credit risk management and bank
failures in Nigeria using survey research design. The results from the Chi-square statistics
revealed that weak corporate governance accelerates bank failures and the credit risk
management function is to the greatest extent the most diverse and complex activity in
banking business. The author concludes that poor credit risk management influences bank
failures.

Michael et al. (2015) developed an effective credit risk management that the credit
management starts with the sales and does not stop until the full and final payment has
been received. The central bank annual supervision report 2015 indicated high incidence
of credit risk reflected in the rising levels of non-performing loans by the commercial
banks in the last 10 years. This results in loan losses when ultimately loan recovery flops
and also creation of provision for doubt debts thus affecting overall profitability.
Therefore, this study aims at assessing the effectiveness of credit appraisal on loan
performance in commercial banks in Kenya. It was intended to be of significance to
various parties namely the banks management, customers, investors and even the
government. It was suffered difficulties due confidentially of credit information but the
researcher obtained an introductory letter from the university and assured responds of
confidentiality. Descriptive research design was used. The population comprised of 86
respondents. Data was collected using a self-administered questionnaire through drop and
pick later method. The questionnaire was both open and closed ended. Test retest method
was used to ensure reliability while piloting was used to check the validly of the research
instrument .data was analyzed using to frequencies, percentages and means. Correlation
was used to compute the degree of association between variable. The hypotheses were
tested using chi square. Data was thereafter presented using table and pie charts. Credit
appraisal was found to be very important in influencing performance of commercial
banks. Findings revealed that lending placed much reliance on use of past information
and thus credit referencing and credit history were applied more in credit appraisal. It was
recommended that credit appraisal should be carried out by the technical people who are
experienced and competent credit officers. Use of a multi-variety approach to credit risk
appraisal was also recommended.

Shing & Shahid (2016) investigated that how well the banking sector of Oman is
managing their liquidity risk by comparing them with some of the leading multinational
banks. The liquidity ratios are used to compare the liquidity risk of domestic banks with
the multinational banks. Frequently used liquidity ratios were calculated and compared
for the period of three years from 2012 to 2014 using descriptive and analytical approach.
On the basis of liquidity ratios the two domestic banks of Oman are weak in liquidity
management as compared to their international counterpart .However, Central bank of
Oman monitors the liquidity reports of each bank, policies are reviewed and approved by
the risk committee of banks. Moreover, the Omani local banks also frequently conduct
stress testing based on the market situations and bank conditions as per the standard laid
down by the Basel Committee.

Bassey et al. (2016) examined the liquidity management and the performance of banks in
Nigeria within the period 2000-2010. It investigated the relationship between the
variables of bank performance and those of liquidity management using bank deposit,
cash reserve requirement, bank investment, and cash ratio as indicators. Data were
mainly collected from CBN’s statistical bulletin. Data were analyzed using simple
percentages and simple regression model. Findings indicated that a strong relationship
exists between bank deposit and bank reserve requirement, and bank investment and cash
ratio. Thus, these finding which had re-echoed results from similar studies re-emphasize
the fact that successful operations and survival of banks anchored on efficient and
effective liquidity management. Therefore, it was recommended that banks should not
concentrate purely on deposits but rather other measures be adopted to reduce illiquidity
in this sector.

Wambui & Wanjim (2016) determined the effect of credit risk on corporate liquidity of
deposit taking microfinance institutions (DTMs) in Kenya. The population of the study
comprised all the nine DTMs in Kenya. The data for the study was collected from
secondary sources for the period between 2011 and 2013. Regression analysis was used
to determine the strength of the relationship between the variables. The findings of the
study indicated that credit risk has a strong and a statistically significant effect on
corporate liquidity of deposit taking microfinance institutions in Kenya.

Davronov (2016) studied the existing mechanisms of liquidity management in practice of

commercial banks in Uzbekistan. In addition, it presents description and grouping of
theoretical approaches to the liquidity management in commercial banks. He also
formulated main requirements to the mechanism of liquidity management process.
Moreover, it proposes and demonstrates the results of testing mathematical model of
analysis and forecast of bank cash flows which is based on ARIMA method. It should be
noted that the model, proposed in the article, cannot entirely optimize the activity of the
bank and minimize risks of liquidity management. On the one hand, it is connected with
the fact that the forecast for future cash flows of the bank is made with the certain
probability. Thus if we raise the time series, the reliability of the results will be
decreased.

Coleman et al. (2017) explained the patterns of internal liquidity management and their
effect on bank lending, using a novel branch-level dataset of Brazilian banks. The results
suggest that internal liquidity management increases during times of financial stress.
Privately owned banks are most affected by a liquidity shock, and increase the level of
internal funding to maintain their branch lending, while their government-owned
competitors react strategically. Private and government banks increase the funding of
branches in concentrated and riskier areas. This funding translates into more lending, as
the sensitivity of lending to internal funding remains high after the liquidity shock.
Altogether, the paper provided branch-level evidence of the way that banks ration
internal liquidity, both in normal times and in times of stress, and the effect this has on
bank lending.

Ejong et al. (2014) examined the impact of credit risk and liquidity risk management on
the profitability of deposit money banks in Nigeria with particular reference to First bank
of Nigeria Plc. Descriptive research design was used for the study where questionnaires
were administered to a sample size of eighty (80) respondents. The data obtained were
presented in tables and analyzed using simple percentages. The formulated hypotheses
were tested using the Pearson product moment correlation.

2.3 Relationship between Liquidity and Profitability

Profitability and liquidity are the most prominent issues that management of each
organization should take studying and thinking about them into account as their most
important duties. Liquidity refers to the ability of a firm to meet its short term
obligations. Liquidity plays a crucial role in the successful functioning of a business firm.
A study of liquidity is of major importance to both the internal and external analysts
because of its close relationship with day to day operations of a business, (Bhunia, 2010).

For a bank, the words liquidity and profitability come again and again. There is no
possibility of profitability without liquidity. Also, there is no growth in liquidity without
profitability. These are complement to each other. But these two also are opponent to
each other. If there is high liquidity in bank, the bank can't gain profit. Because, most part
of the liquidity is reserved in the bank, it doesn't give profit to the bank. The bank can't
invest the amount. It is not possible to hope profitability without investment, (Budha,
2016).

For profitability, the bank has to keep liquidity low in the bank, invest the cash fund, it
can gain profit after some time but it can invite a great accident to the bank. If there is no
maintenance of liquidity in the bank as a balance form, the bank can't carry out its
banking transaction. Different obstructions may come to banking transaction, not only the
bank losses, its business, but also destroys the reputation of bank. Eventually, it becomes
matter of great loss for the investors, creditors and the nation who invested the amount on
it.

Of all fundamental and sound lending principles of the investment policy, the principality
of liquidity and profitability are very much crucial. In the lack of liquidity the bank can't
give payment to the depositors in the time of their demand, and can't pay the loan to the
creditors. The bank's daily work can't be run. The bank, under the law can't keep and
maintain the capital funds. Not only this much, the bank also becomes unable to face any
economic rise and fall occurring in coming days. So, to keep liquidity is very important.
If high liquidity is harmful to the bank, liquidity crisis too is malignant to the bank. To be
free from both of these two conditions, the bank should be able to maintain balance of
liquidity.

Similarly, the bank should keep in balance the principle of profitability. If there remains
high liquidity in the bank, the bank will be successful in its goal. The commercial banks
always are intensified with the concept of gaining profit. So, they are eager to invest in
the profitable sectors. To gain much profit, they should be able to flow long term loan,
short term and mid-term loan which brings profit to the bank. The bank always follows
the principle of profitability more carefully. Sometimes, the bank, with the view point of
gaining profit and safety, invests in the sectors that are considered less important, from
which it can earn much profit or loss. This is a matter which depends on time and
situation. It is very difficult for the bank to discharge both of these function together, to
keep liquidity and earn profit are compulsory for the bank. But if the bank without
carrying both these principles moves forward, it becomes unsuccessful in its goal. The
bank should not forget these two principles all the time. It should be able to maintain
these principles in balance all the time. The bank should maintain understanding between
these two principles.

If the bank attempts to run its transactions ignoring these two principles, certainly the
bank will bear an economic disaster. Hence, the bank gives emphasis upon the necessity
of internal co-ordination between liquidity and profitability due to following reasons:

 Liquidity is necessary to make payment of all sorts of deposits.

 Liquidity is necessary to save the bank from the economic rise and fall.
 The bank should not keep high (much) liquidity to gain profit.
 In the lack of profitability, the bank can’t be operated.
 Also, if there is liquidity crisis in the bank, it can’t be run.
 Also, the bank should earn much profit to pay the shareholders, creditors and the
employees of the bank.
 Also, for competition, the bank should gain profit.
 The bank can’t manage its transactions without gaining profit.

With the above mentioned reasons, the liquidity and the profitability have their peculiar
importance in the bank. So, from business point of view, it is necessary to maintain
balance, between principalities of liquidity and profitability, (Bhandari, 2013)

A Bank must preserve adequate amount of liquidity to meet its daily obligations but
liquidity in excess of what is adequately required by the company to finance it operations
may be counter-productive. The liquidity requirement of firms differs depending on the
circumstances of the company, (Pandy, 2005). Theoretically a company requires
preserving a liquidity level that is not detrimental to its profitability. Empirical evidence
shows a negative correlation between liquidity and profitability but a company cannot
operate with zero liquidity in order to maximize its profits. This relationship is depicted
using figure 1.1; liquidity increase leads to increase in profitability (point A to B) up to a
certain point where any further increase in liquidity; profitability remains constant (point
B to C) beyond this point any further increase in liquidity will lead to decrease in
profitability (point C to D).

2.4 Review Article in the National Context

Koirala (2010) assessed the record of accomplishment of potential borrowers and

innocent characters termed as the best borrower. The bank, on the other hand is an
institution established have been responsible for the existence of huge volume of NPA in
state-owned commercial banks. In order to improve the situation, there is a need to
evolve a more acceptable working system backed by cooperation and realization by the
banks employees as well as the politicians and stakeholders, who can influence in banks
operation.

Gautam (2012) analyzed financial performance of commercial banks using both

descriptive and diagnostic approach. It was concluded the following points:

 The structural ratio of commercial banks shows that banks invest on the average of
 75% of their total deposit on the government securities and the shares.
 The analysis of resource position of commercial banks should quit high percentage
of deposit as cash reserve.
 .Return ratio of all the banks show that most of the time foreign banks have higher
return as well as higher risk than Nepalese banks.
 The debt – equity ratios of commercial banks are more than 100% in most of the
time period under studies period. It led to conclude that the commercial banks are
highly leveraged and highly risky. JVBs had higher capital adequacy ratio but has
been dealing every day.
 In case of the analysis of the management achievement, foreign banks have
comparatively higher total management achievement index.

Shrestha (2012) conducted the role of deposit mobilization and its problems and
prospects in context of Nepal using descriptive and diagnostic approach for the study of
banks and has presented that following problems in the context of Nepal:

 People do not have knowledge and proper education for institutional manner. They
so do not know financial organizational process, withdraw system, depositing
system etc.
 Financial institutions do not want to operate and provide their services in rural
areas.
 He has also recommended about how to mobilize the deposit collection by the
financial institutions by rendering their services in rural areas and by adding
various services.
 By operating rural banking programs and unit, mobilize the deposit collection by
the financial institutions by rendering their service in rural areas, by adding
various services.
 Nepal Rastra Bank must organize training programs to develop the skill human
resources.
 By spreading a numbers of co-operative societies to develop mini banking services
and improves the habits of public in deposit collection to the rural areas.

Poudel (2012) examined the impact of credit risk management on the financial
performance of commercial banks in Nepal using the financial report of 31 banks for
eleven years (2001-2011). The methods of data analysis in the study were descriptive,
correlation and multiple regressions. The financial performance indicator used in the
study was return on assets (ROA). The predictors of the banks‟ financial performance
used in the study were: default rate, cost per loan assets and capital adequacy ratio. The
author asserts that all these parameters have an inverse impact on banks‟ financial
performance. However, among the risk management indicators, default rate (NPLR) is
the single most influencing predictor of bank financial performance in Nepal whereas
cost per loan assets is not significant predictors of bank performance. The author
concludes that credit risk management is crucial on the bank performance since it have a
significant relationship with bank performance.

Bhattarai (2016) examined the effect of credit risk on performance of Nepalese

commercial banks. The descriptive and causal comparative research designs have been
adopted for the study. The pooled data of 14 commercial banks for the period 2010 to
2015 have been analyzed using regression model. The regression results revealed that
'non-performing loan ratio' has negative effect on bank performance whereas 'cost per
loan assets' has positive effect on bank performance. In addition to credit risk indicators,
bank size has positive effect on bank performance. Capital adequacy ratio and cash
reserve are not considered as the influencing variables on bank performance. This study
concludes that there is significant relationship between bank performance and credit risk
indicators.

CHAPTER- II

RESEARCH METHODOLOGY
This chapter refers to the overall research method followed by us in analyzing the
objectives outlined.

This study covers quantitative methodology in greater extent and also uses the descriptive
part based on both technical aspects and logical aspects. This research tries to perform a
well-designed quantitative and qualitative research in a very clear and direct way using
both financial and statistical tools.

2.1 Research Design

The study basically follows the descriptive as well as analytical research design.
Financial and statistical tools have been applied to examine facts and descriptive
techniques have been adapted to evaluate investment performance of CBs. Besides these,
some simple questions have been asked to the concerned personnel in the course of
visiting the bank. This report also contains other primary data. This report is mainly
based on secondary data, which include annual reports published by the concerned banks
and other publications related to the concerned topic.

2.2 Sources of Data

The study is based on secondary data. The data required for the analysis are directly
obtained from the balance sheet and P\L account of concerned banks’ annual reports.
Supplementary data and information are collected from number of institutions and
regulating authorities like NRB, SEBON, NEPSE, Ministry of Finance, and budget
speech of different fiscal years and economic survey.

All the secondary data are complied, processed and tabulated in the time series as per the
need and objectives of the study. Likewise various data and information are collected
from the economic journals, periodicals, bulletins, magazines and other published &
unpublished reports and documents from various sources. Formal and informal talks with
the concerned authorities of the banks are also very helpful to obtain the additional
information of the related problem.

2.3 Population and Sample

There are altogether 28 commercial banks functioning in the country. Out of 28

commercial banks in Nepal there are 6 joint venture natured banks and for the study only
Nabil Bank Limited has taken as a sample by In this study, using convenience sampling
method and also be taken 5 years data from the time period of 2016/17 to 2020/21.

Their data relating to investment policy (liquidity management) are studied and
compared.

2.4 Method of Analysis

Various financial, accounting and statistical tools are used to make the analysis more
effective, convenience, reliable and authentic. The analysis of data is done according to
the pattern of data available because of limited time and resources. Simple analytical
statistical tools such as percentage, Karl Person’s coefficient of correlation, regression,
and the method of least square and test of hypothesis are used in this study. Similarly,
some accounting tools such as ratio analysis and trend analysis have also been used for
financial analysis. The various tools applied in this study have been briefly presented as
under:

2.4.1 Financial Tools

Financial tools are used to examine the financial strength and weaknesses of bank in this
study.

Ratio Analysis

Ratio analysis is the relationship between two accounting figures expressed

mathematically. It is computed by dividing one item of relationship with the other.
Management itself can use these parameters to improve the organization’s performance.
The knowledge regarding strengths and weakness is necessary for exploiting maximum
benefits and to repair the weaknesses to meet the challenges. The financial ratios, which
are calculated and analyzed in this study, are as follows:

A) Liquidity Ratios

Liquidity ratios measure the firm’s ability to meet current obligations. It reflects the
short-term financial strength of the business. It is the measurement of speed with which a
bank’s assets can be converted into cash to meet deposit withdrawal and other current
obligations. A bank should ensure that it does not suffer from luck of liquidity and also it
does not have excess liquidity. Both condition of liquidity are not in favor of the banks.
The following ratios are evaluated under liquidity ratios.

i) Current Ratio

The ratio between current assets and current liabilities is known as current ratio. It shows
the relationship between current assets and current liabilities. Current assets are those
assets, which can be converted into cash within short period of time, normally not
exceeding one year. Current liabilities are those obligations, which are payable within a
short period, normally not exceeding one year.

Mathematically it is expressed as,

Current Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿i𝑎𝑏i𝑙i𝑡i𝑒𝑠

Higher the current ratio better is the liquidity position. The widely accepted standard of
current ratio is 2:1 but accurate standard depends on circumstances in case of seasonal
business ratio.

This ratio measures the bank’s short-term solvency i.e. its ability to meet short-term
obligations. As a measure of creditors versus current assets, it indicates each rupee of
current assets available for each rupee of current liability.

ii) Cash and Bank Balance to Total Deposit Ratio (Cash Reserve Ratio)

Cash and Bank Balances are the most liquid current assets. This ratio measures the
percentage of most liquid fund with the bank to make immediate payment to the

depositor. This ratio is calculated by dividing the cash and bank balance by the amount of
total deposits. Mathematically, it is expressed as,

Cash Reserve Ratio = 𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝐵𝑎𝑛𝑘 𝐵𝑎𝑙𝑎𝑛𝑐𝑒

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑝𝑜𝑠i𝑡
Hence, cash and bank balance includes cash on hand, foreign cash on hand, cheques and
other cash items, balance with domestic and abroad banks whereas the total deposits
include current deposits, saving deposits, fixed deposits, money at call and short-term
notice and other deposits.

iii) Cash and Bank Balance to Current Assets Ratio

This ratio measures the proportion of most liquid assets i.e. cash and balance among the
total current assets of the bank. Higher ratio shows the banks’ ability to meet its demand
for cash.

This ratio is calculated by dividing cash and bank balance by current assets.
Mathematically, it is expressed as,
Cash and Bank Balance to Current Assets Ratio = 𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝐵𝑎𝑛𝑘 𝐵𝑎𝑙𝑎𝑛𝑐𝑒
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

iv) Investment on Government Securities to Current Assets Ratio

Investment on government securities includes treasury bills and development bonds etc.
This ratio is calculated to find out the percentage of current assets invested in government
securities.

This ratio is calculated by dividing investment made on government securities by current

assets. Mathematically it is expressed as,

Investment on Govt. Securities to Current Assets Ratio = 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑜𝑛 𝐺𝑜𝑣𝑡

𝑆𝑒𝑐𝑢𝑟i𝑡i𝑒𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

v) Loan and Advance to Current Assets Ratio

Loan and advances to current assets ratio shows the percentage of loan and advances in
the total current assets, where loan & advances by current assets.

Mathematically it is expressed as,

Loan and Advances to Current Assets Ratio =𝐿𝑜𝑎𝑛 𝑎𝑛𝑑 𝐴𝑑𝑣𝑎𝑛𝑐𝑒𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

B) Assets Management Ratio (Activity Ratios)

Activity ratios are employed to evaluate the efficiency with which the firm manages and
utilizes its assets. Assets management ratio measures how efficiently the bank manages
its resources.

The following ratios are used under asset management ratio.

i) Loan and Advances to total Deposit Ratio

This ratio is calculated to find out that which banks are able to utilize their total deposits
on loans and advances for profit generating purpose. This ratio can be obtained by
dividing loan and advances by total deposits, which can be stated as,

Loan and Advances to Total Deposit Ratios = 𝐿𝑜𝑎𝑛 𝑎𝑛𝑑 𝐴𝑑𝑣𝑎𝑛𝑐𝑒

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑝𝑜𝑠i𝑡

ii) Total Investment to Total Deposit Ratio

This ratio implies the utilization of firm’s deposit invested in government securities and
share & debentures of other companies and bank.

This ratio can be calculated by dividing total investment by total deposit. It can be stated
as,

Total Investment to Total Deposit Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑝𝑜𝑠i𝑡

iii) Loan and Advances to Working Fund Ratio

Loan and advances indicates the ability of any bank to canalize its deposits in the form of
loan and advances to earn high return. This ratio is computed by dividing loan and
advances by total working fund, which can be stated as,
Loan and Advances to Working Fund Ratio = 𝐿𝑜𝑎𝑛 𝑎𝑛𝑑 𝐴𝑑𝑣𝑎𝑛𝑐𝑒
W𝑜𝑟𝑘i𝑛𝑔 𝐹𝑢𝑛𝑑

Where, total working fund consists of current assets, net fixed assets, loan for
development banks and other miscellaneous assets.

iv) Investment on Government Securities to Total Working Fund Ratio

This ratio shows that banks’ investment on government securities in comparison to the
total working fund.

This ratio is calculated by dividing investment on government securities by total working

fund, which can be stated as,

Investment on Government Securities to Total Working Fund Ratio

= 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑜𝑛 𝐺𝑜𝑣𝑡,i𝑡i𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 W𝑜𝑟𝑘i𝑛𝑔 𝐹𝑢𝑛𝑑

Investment on government securities includes treasury bills and development bonds etc.

C) Profitability Ratios

Profit is the difference between revenues and expenses over a period of time. A company
should earn profit to survive and grow over a long period of time. Therefore, the financial
manager should continuously evaluate the efficiency of its company in terms of profits.
The profitability ratios are calculated to measure the operating efficiency of a company. It
is the indicator of the financial performance of any institution. This implies that higher
the profitability ratio, better the financial performance of the bank and vice versa. The
following ratios are taken into account under this heading.

i) Return on Total working Fund Ratio

This ratio measures the overall profitability of all working funds I.e. total assets. A firm
has to earn satisfactory return on assets or working fund for its survival. This ratio is
calculated by diving net profit by total working fund.

This can be expressed as,

Return on Total Working Fund Ratio = 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓i𝑡
W𝑜𝑟𝑘i𝑛𝑔 𝐹𝑢𝑛𝑑

ii) Return on Loan & Advance Ratio

This ratio indicates how efficiently the bank has employed its resources in the form of
loan and advances. This ratio is computed by dividing net profit by loan and advances.

This ratio can be expressed as,

Return on Loan & Advances Ratio = 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓i𝑡

𝐿𝑜𝑎𝑛 & 𝐴𝑑𝑣𝑎𝑛𝑐𝑒

iii) Total Interest Earned to total outside Assets Ratio

This ratio measures the interest earning capacity of the bank through the efficient
utilization of outside assets. Higher ratio implies efficient use of outside assets to earn
interest. This ratio is calculated by diving total interest earned by total outside assets.

It is expressed as,

Total Interest Earned to Total outside Assets Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑎𝑟𝑛𝑒𝑑
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

iv) Total Interest Earned to Total Working Fund Ratio

This ratio is calculated to find out the percentage of earned to total assets (working fund).
Higher ratio implies better performance of the bank in terms of interest earning on its
total working fund. This ratio is calculated by diving total interest earned by total
working fund.

It can be expressed as,

Total Interest Earned to Total Working Fund Ratio =𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑎𝑟𝑛𝑒𝑑
𝑇𝑜𝑡𝑎𝑙 W𝑜𝑟𝑘i𝑛𝑔 𝐹𝑢𝑛𝑑
Where, total interest earned includes, interest on loan, advances and overdraft,
government securities, investment debentures and other inter-bank loans.

v) Total Interest Paid to Total Working Fund Ratio

This ratio is calculated to find out the percentage of paid on liabilities with respect to total
working fund. This ratio is calculated by dividing total interest paid by total working fund
which is expressed as,

Total Interest Paid to Total Working Fund Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃𝑎i𝑑
𝑇𝑜𝑡𝑎𝑙 W𝑜𝑟𝑘i𝑛𝑔 𝐹𝑢𝑛𝑑

Where, total interest paid includes total expenses on deposits, loan and advances,
borrowings and other deposits.

D) Risk Ratios

Risk taking is the prime business of banks’ investment management. It increases

effectiveness and profitability of the bank. These ratios indicate the amount of risk
associated with the various banking operations, which ultimately influences the banks’
investment policy.

The following ratios are taken into account under this heading.

i) Liquidity Risk ratio

This ratio measures the level of risk associated with the liquid assets i.e. cash, bank
balance etc. that are kept in the bank for the purpose of satisfying the depositors’ demand
for cash. Higher the ratio, lower is the liquidity risk.

Mathematically it is presented as,

Liquidity Risk Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐶𝑎𝑠ℎ & 𝑏𝑎𝑛𝑘 𝑏𝑎𝑙𝑎𝑛𝑐𝑒

𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑝𝑜𝑠i𝑡

ii) Credit Risk Ratio

This ratio measures the possibility that loan will not be repaid or the investment will
deteriorate in quality or result in loss to the bank. By definition, it is expressed as the
percentage of non-performing loan to total loan & advances.

Mathematically it is presented as,

Credit Risk Ratio = 𝑇𝑜𝑡𝑎𝑙 𝐿𝑜𝑎𝑛 & 𝐴𝑑𝑣𝑎𝑛𝑐𝑒𝑠

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

2.4.2 Statistical Tools

Some important statistical tools are used to achieve the objective of this study. In this
study, statistical tools such as trend analysis of important variables, co-efficient of
correlation between different variables as well as test of hypothesis have been used which
are as follows:

a) Trend Analysis

This topic analyzes the trend of loan and advances to total deposit ratio and trend of total
investment to total deposit ratio of NABIL & SBI bank from 2012\2013 to 2016\2017
and makes the forecast for the next five years. Under this topic following sub- topic have
been presented.

i) Trend analysis of loan and advances to total deposit ratio.

ii) Trend analysis of total investment to total deposit ratio.

b) Co-efficient of Correlation Analysis

This analysis identifies and interprets the relationship between the two or more variables.
In the case of highly correlated variables, the effect on one variable may have effect on
other correlated variable under this topic. Karl Pearson’s co-efficient of correlation has
been used to find out the relationship between the following variables.

i.) Co-efficient of correlation between deposit and loan and advances.

ii.) Co-efficient of correlation between deposit and total investment.
iii.) Co-efficient of correlation between total outside assets and net profits.
These tools analyze the relationship between these variables and help the banks to make
appropriate policy regarding deposit collection, fund utilization (loan & advances and
investment) and maximization of profit.

This tools is used for measuring the intensity or the magnitude of linear relationship
between two variable X and Y is usually denoted by ‘r’ can be obtained as
= N ∑ XY− ∑ X ∑ Y
√N ∑ X2− (∑ X)2 √N ∑ Y2− (∑ Y)2

Where,

N = no. of observation in series X and Y

∑X = Sum of observation in series X
∑Y = Sum of observation in series Y
∑ X2 = Sum of square observation in series X
∑ Y2 = Sum of square observation in series Y
∑XY = Sum of the product of observation in series X and Y

The result of coefficient of correlation is always between -1 to +1, where r= +1 means

there is a positive relationship between two variables and where r=-1, means there is a
negative relationship between two variables.

II. Coefficient of Determination (r2)

It explains the variation percent derived in dependent variable due to the any one
specified variable; it denotes the fact that the independent variable is good predictor of
the behavior of the dependent variable. It is square of correlation coefficient.

III. Probable Error of Correlation

The probable error of the co-coefficient of correlation helps in interpreting its value; it is
obtained the following formula.
P. E. = 0.6745 1− r2 v
√n

It is used in interpretation whether calculated value of ‘r’ is significant or not.

1. If r < P.E., it is insignificant. So, perhaps there is no evidence of correlation.

2. If r > P.E., it is significant.
3. In other cases nothing can be concluded.

CHAPTER – III
 SUMMARY AND CONCLUSION

3.1 Summary

Liquidity management can overall describe the security management of the cash balance
in a systematic and scientific way. Liquidity is that part of the total assets, which can be
paid immediately to meet the current obligation. The liquidity management is used to
describe money and assets that are readily convertible into money within very short span
of time. The liquidity of assets refers to the ease and certainty with which it can be turned
into cash. Bank maintain liquidity in the form of cash and bank balance, placement of
money at call or short notice and investment in government securities and other securities
readily convertible into cash. It is such a large proportion of deposit payable on demand.
Inadequate liquidity tarnishes the image of the organization while excess liquidity is
detrimental to the profitability.
Profitability is the net result of a large number of policies and decisions. The rations
examiner thus far provide some information about the way the firm is operating, but the
profitability ratios show the combined effects of liquidity, assets management and debt
management on operating results. Profitability ratio is a widely used tool of financial
analysis. It is defined as the systematic use of ratio to interpret the financial statements so
that the strength and condition can be determined. While computing the ratios, they do
not add any information; they only reveal the relationship in a more meaningful way to
enable us to draw conclusions from them. Further, in financial analysis, and performance
of the firm. It helps in making decisions as it helps establishing relationship between
various ratios and interpret them. It helps as analyst to make quantitative judgment about
the financial position and performance of the firm.

The main objective of this study is to analyze the Liquidity and profitability position of
the Nepal Bank Limited is taken as sample. To achieve the objectives set out, different
financial tools like liquid assets trend, Cash reserve ratio, cash and bank balance to total
deposit, fixed assets to total deposit, net profit margin, return on shareholders’ equity,
total assets, return on return on total deposit and others were analyzed.

For this study, it is used only secondary data analysis. The study used only Nepal Bank
Limited as a sample of the study. Further the researcher applied quantitative research for
achieving the objectives of the study. Moreover, the study will follow descriptive and
causal comparative research design.
3.2 Conclusion

In conclusion, it can be said that liquidity and profitability analysis is one of the most
important parts of every financial institutions. It can be concluded that the liquidity
position of Nepal Bank Limited is better than that of other banks, as the current ratio of
had the practice of higher percentage of total deposit collected in the form of cash and
bank balance has remained successful to meet the standard set by NRB for cash reserve
ratio in all fiscal year. It can be concluded that the liquidity position of Nepal Bank
Limited is more satisfactory than that other Commercial Banks. The average fixed
deposit to total deposit ratio of Nepal Bank Limited is higher than Other Banks. Higher
average ratio shows that Nepal Bank Limited has maintained enough fixed deposit in
relation to its total deposit than Other Bank average current deposit to total deposit ratio
is higher and which shows RBB managed enough proportion of current deposits among
total deposits to meet its short term demand or liquidity.

On the basis of net profit margin, it can be concluded that the NBL is more successful in
controlling the operating and other non-operating cost; as a result NBL net profit margin
is higher. The return on assets of NBL is which clearly indicated that NBL is more
successful in generating profit from the investment in total assets. The shareholders of
NRB remained more satisfied as NBL generated more percentage of return from
shareholders’ equity and remained more successful in mobilizing total deposit to generate
profit. Thus, the profitability position of NBL is better is much artisan in mobilizing the
shareholders’ equity to earn high profit per share. As a result both the existing
shareholders’ and the potential investors might have been fascinated toward the NBL for
being part of it by buying its share.