MANAGEMENT OF LIQUIDITY AND FINANCIAL PERFORMANCE OF THE NIGERIA INSURANCE SECTOR
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ABSTRACT
This study investigated the effect of liquidity management and financial performance on the Nigerian insurance sector. This study drew its secondary data from textbooks, journals, magazines, and newspapers. Our findings reveal a correlation between liquidity management and the profitability of the Nigerian insurance sector. On the basis of these findings, we recommend that lenders be prudent when extending credit to their clients/customers in order to avoid the problem of load loss management, and that the financial system’s competence be improved in order to increase asset quality.
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FIRST PART
INTRODUCTION
1.1 INTRODUCTION TO THE STUDY
In light of the current financial climate and the health of the global economy, liquidity management is a concept that is garnering significant global attention. Notable corporate objectives include the need to maximize profit, maintain a high level of liquidity to ensure safety, and attain the highest level of owner’s net worth in conjunction with other corporate objectives. It is impossible to overstate the significance of liquidity management as it relates to company profitability in modern business. The most important aspect of managing working capital is maintaining its liquidity on a daily basis to ensure its smooth operation and fulfillment of obligations (Eljelly, 2004). Liquidity plays a crucial part in the effective operation of a corporation.
Liquidity requires meeting obligations as they mature and balancing current assets and current liabilities. Jensen (1986) observes that companies are under pressure when their liquidity level is low and their working capital is negative. This is because either insufficient or excessive liquidity can be detrimental to the organization’s operations (Janglani and Sandhar, 2013). Almeida et al. (2002) proposed a theory of corporate liquidity demand predicated on the assumption that decisions regarding liquidity will be influenced by firms’ access to capital markets and the significance of future investment to the firms. The model predicts that financially limited enterprises will set aside a portion of their incremental cash flows, whereas unconstrained firms will not. Due to the predicted losses that occur from forgoing lucrative investment opportunities, organizations with a bigger investment opportunity set incur a higher cost in the event of a liquidity crisis. A liquid organization takes advantage of accessible investments, cash discounts, and cheaper borrowing rates. Consequently, there is a connection between cash on hand and investment opportunities and, by extension, financial performance.
Some banks and other financial organizations had difficulties during the financial crisis due to violations of fundamental liquidity management standards. In 2008, the Committee issued Principles for Sound Liquidity Risk Management and Supervision (“Sound Principles”) as the core of its liquidity framework. Liquidity is a bank’s capacity to support asset growth and meet commitments as they become due without incurring unacceptable losses (Basel Committee on Banking Supervision, 2013). The liquidity of an asset is contingent upon the underlying stress condition, the volume to be monetised, and the timescale taken into account. Therefore, efficient and effective liquidity management is essential for a company’s existence and growth. According to the Banking Act (2014) and CBK Prudential Guideline (2013), an institution is required to maintain a minimum level of liquid assets as determined by the Central Bank. Statutorily, Kenyan banks must retain a minimum of twenty percent (20%) of their deposit liabilities, maturing obligations, and short-term liabilities in liquid assets. The Liquidity Ratio is determined by total short-term obligations and net liquid assets.
1.2 DESCRIPTION OF THE PROBLEM
As uncertainty caused funding sources to disappear during the previous financial crises, many financial organizations, particularly banks, quickly ran out of funds to meet their obligations as they matured (Bordeleau,2010). In the aftermath of the crisis, there was a widespread perception that institutions had underappreciated the significance of liquidity management and the implications of such risk for the firms themselves and the financial system as a whole. As liquid assets such as cash and government securities typically yield a low rate of return, a financial institution may incur opportunity costs by holding them. In the absence of regulation, it is reasonable to assume that businesses will hold liquid assets to the extent that doing so maximizes their financial performance and profitability. Beyond this, policymakers have the flexibility to mandate bigger liquid asset holdings, for instance, if it is deemed beneficial to the overall financial system’s stability. How to determine or identify the optimal point or level at which a financial institution can hold its liquid assets to maximize its return becomes the difficulty. As an increasing number of institutions, particularly financial companies, are preoccupied with profit and performance maximization, they tend to overlook the significance of liquidity management.
Problems can also arise from a bank’s insatiable desire to generate spectacular profits. There is a propensity for these institutions to become careless in their exploitation of resources and particularly their management of liquidity.
The outcome is typically loss substance and, subsequently, loss accumulation, a circumstance that might culminate in the failure of a bank. The marginal loans in the banking system reminds us of the crucial truth that national governments must always be concerned with banks. This demonstrates the significance these governments place on liquidity and its management, and any deviation from its ratio or insufficiency in its management invariably bodes trouble for the banks involved.
Additionally, the far-reaching effects of insufficient liquidity management might be investigated. Apart from profit decreases. Loss of faith in the particular bank, inability to meet both short-term and long-term obligations, lack of trust on the part of depositors and other customers, and concurrent drop in level of operations are additional effects.
A recent illustration of the imminent trouble Nigerian banks face as a result of incorrect liquidity position management and loan loss piling is the Nigerian Central Bank (marginal loans). These issues make it very clear that the Nigerian insurance industry’s liquidity management and financial performance must be investigated.
1.3 OBJECTIVES OF THE RESEARCH
This study seeks to examine the liquidity management and financial performance of the Nigerian insurance market. The particular aims are:
To investigate the liquidity status of the Nigerian insurance market in depth.
Identifying the causes of illiquidity and the elements that affect liquidity management.
Examine the ability of the Nigerian insurance industry to adapt its liquidity and control management to the Nigerian financial climate.
MANAGEMENT OF LIQUIDITY AND FINANCIAL PERFORMANCE OF THE NIGERIA INSURANCE SECTOR
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