International Journal of Empirical Finance

Vol. 2, No. 4, 2014, 143-151

Liquidity-Profitability Relationship in Bangladesh Banking Industry

Afia Akter1, Khaled Mahmud2
Abstract
This study explored the relationship between liquidity (measured as current ratio) and profitability (measured
as return on assets) in the banking industry in Bangladesh. We have considered twelve banks in four different
sectors (Government banks, Islami banks, multinational banks and private commercial banks). We tried to
figure out how much liquidity of a bank can explain its profitability. We ran linear regression to find out the
extent of relationship between banks liquidity and profitability (significance level was 10%). Individually all
the sectors show no significant relationship between liquidity and profitability. Even the overall banking
industry shows the same result. We considers year just before recession (2006) to post-recession (2011). We
showed graphically how liquidity and profitability of these sectors varied over last couple of years.
Government banks showed variable liquidity, while other sectors were steady. But, there were much
fluctuations in profitability in between these times in all the sectors. Finally, we concluded that based on our
sample and category, there is no significant relationship between liquidity and profitability in banks of
different sectors in Bangladesh.
Keyword: Liquidity, Profitability, Relationship, Bangladesh, Banks.
1. Introduction
Banking is one of the most sensitive businesses all over the world and they are playing very important
role in economy. They do influence and facilitate to integrate the economic activities like resources
mobilization, production activities, distribution of public finance, and often social wellbeing. Banking Sector
of Bangladesh consists of private commercial Banks, islami banks, multinational bank, government banks,
and the Central Bank of Bangladesh.
Liquidity and profitability are two very crucial issues that organizations management always considers
evaluating the financial health of the company. There is an extensive body of literature that seeks to identify
the determinants of financial performance of banks. Hultman and McGee (1989), and Peek et al. (1999)
focus on the understanding of foreign banks performance in a particular country. In contrast, John (2004),
and Khalid (2006) report the determinants of growth and banks profitability. It is widely acknowledged that
liquidity is one of the driving factors affecting the likelihood of a bank failure (Arena 2008).
Liquidity is a measure of the availability of cash for use in the day to day business. A liquid asset is one
that is cash or can easily be turned into cash. Liquidity plays a crucial role to both the internal and external
analysts because of its close relationship with day-to-day operations of a business (Bhunia, 2010). Weaker
liquidity position poses a threat to the solvency as well as profitability of a firm and makes it unstable
(Niresh, 2012). 'Current ratio' and the 'quick ratio' are two common measures of the liquidity of a company.
Usually a high current ratio is considered to be an indicator of the firm's ability to promptly meet its shortterm liabilities.
Profitability is a measure of the amount by which a firms revenues exceeds its relevant expenses
(Niresh, 2012). It is the potential of making profits that encourage entrepreneurs to take risks to invest in a
1
2

Assistant Professor Department of Business Administration Northern University Bangladesh

Assistant Professor Institute of Business Administration University of Dhaka Bangladesh

2014 Research Academy of Social Sciences

http://www.rassweb.com

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A. Akter & K. Mahmud

business, so the first role of profits is to reward owners for risks taken when investing in a business.
Profitability is a measure of the amount by which a company's revenues exceeds its relevant expenses
(Owolabi et al, 2011). A low profit margin would suggest ineffective management and investors would be
hesitant to invest in the company. (Niresh, 2012).
Gross profit margin is an indicator of the profit a business after cost of goods sold. This profit is earned
before any administration, selling and so on. Net profit margin is an indicator of the amount of net profit after
taking account of the cost of sales, the administration costs, the selling and distributions costs and all other
relevant costs. Profitability ratios are used to evaluate the management's ability to create earnings from
revenue-generating bases within the organization.
Excessive liquidity indicates idle funds that dont fetch any profits for the firm (Smith, 1980). On the
other hand, insufficient liquidity might deteriorate firms credit standings and that might lead to forced
liquidation of firms assets (Ajanth, 2013). Hence, the present study is an initiative to identify the
relationship between liquidity and profitability of listed banks in Bangladesh.
This study analyses the liquidity and profitability ratios of different sectors commercial banks in
Bangladesh over a six-year period. The study has five sections. After this introduction, the net section is a
review of related studies done previously. Section three discusses the methodology of the study. Section four
focuses on results and analysis while fifth section concludes the study.
Research Question
The following questions are addressed to identify the relationship (if any) between liquidity and
profitability:
Is there any relationship between liquidity and profitability in banks of Bangladesh?
What is the nature and extent of the relationship between liquidity and profitability in these banks?
Objectives of the Study
To identify the relationship between liquidity and profitability in banking sector of Bangladesh.
To find the nature and extent of the relationship between liquidity and profitability.
2. Empirical Studies
There have been a large number of empirical studies on liquidity profitability analysis of firms around
the world (Ajanthan, 2012; Patel, 2013; Aminu, 2013; Nirish 2012). While a very limited number of studies
emerge to include liquidity as an explanatory variable for bank profitability or vis-veras (Bordeleau, 2010).
Moreover, there is not much study on Bangladesh. However, with the deteriorating health of the banking
institutions and the recent surge of bank failures as a result of the current global financial crisis, it is justified
that bank liquidity and profitability investigation started to increase from both scholars and industry
specialists. To our knowledge, there is no existing empirical work directly focusing on the specific question
considered in the current paper. However, we are able to draw on relevant concepts in some related literature
dealing with relationship between liquidity and profitability of different sectors.
Berger (1995) analyses the statistical relationships between bank earnings and capital for US banks over
the period of 1983-1989. Berger applies the concept of the Expected Bankruptcy Cost Hypothesis in the
realm of capital. It is also conceptually applicable to the impact of liquid assets on profitability. Lepetit et al.
(2008) investigate the relationship between bank risk and profit structure. The study represents that banks
expanding into non-interest income activities present higher insolvency risk than banks, which mainly supply
loans. Demirg-Kunt and Huizinga (2010) support this finding of increased bank fragility associated with a
high proportion of non-interest income and non-deposit funding.
Bordeleau and Graham (2010) in their study found that the impact on profitability of a banks holdings
of liquid assets (i.e., reserves) depends on the amount of funding that comes due in the short-term and on the
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International Journal of Empirical Finance

general state of the economic cycle. All else equal, if a bank is more reliant on short-term funding, it may
need to hold more liquid assets in order to maximize profits and continue its operation.
To find out the relationship between profitability and liquidity Raheman and Nasr (2007) conducted a
study on several Pakistani firms listed on Karachi Stock Exchange and found that there is a strong negative
relationship between liquidity and profitability. Eljelly (2004) in his paper found a significant negative
relationship between the firms profitability and liquidity levels. The study also found that at industry level,
however, the cash conversion cycle is of more importance as a measure of liquidity than current ratio.
Similarly, Jose et al (1996) showed that day-to-day management of a firms short term assets and liabilities
plays an important role in the success of the firm.
The research conducted by Walt (2009) emphasizes more importance on profitability because profit can
usually be turned into a liquid asset. Don (2009) expresses that liquidity is more important as immediate
survival of the company depends on it. Lanberg and Valming (2009) conducted a study on companies listed
on Shochholm Stock Exchange to find out the impact of liquidity on profitability. Their findings suggested
that liquidity strategies do not have significant impact on Return On Assets (ROA).
Owolabi et al (2011) express in their paper that the survival of a business depends on its liquidity. Its
long-term survival, growth and expansion depend on profitability. Therefore both are important for any
company. They investigate liquidity-profitability relationship in three different business sectors like banking,
processing and manufacturing companies in Nigeria. The study results show that liquidity and profitability
are negatively correlated in a banking organization while they are positively correlated in a manufacturing
and processing organization. The study proofs that there is a trade-off between liquidity and profitability in
the banking business and these two reinforce each other in the manufacturing and processing businesses. For
the banking sector, more liquidity implies less profitability, and vice versa. The study shows the cause as a
bank maintains liquidity as regulatory requirement. In conclusion, authors suggest banks should strike a
balance between liquidity and profitability to meet regulatory requirement as well as shareholders wealth
aspirations, where as Manufacturing firms should pursue profit maximization since so doing simultaneously
enhances liquidity and Processing firms should always ensure adequate liquidity, especially raw material
inputs, since it is necessary to remain in operation.
3. Methodology of the Study
In this study, we tried to find out the relationship between liquidity and profitability in the selected
banks in Bangladesh. The study used secondary data for these analyses. The bank-specific data being
examined in this study are derived from both the income statements and balance sheets of commercial banks
published in the website. In addition to this, scholarly articles from academic journals and relevant textbooks
were also used. The sample of this study is confined to banking area consists of 12 banks. Since our study
focuses on the relationship between liquidity and profitability relationship between domestic and foreign
banks, we split the sample into four sub-samples according to their ownership namely; Multinational,
Islamic, Public and Private sector.
For liquidity measure we considered current assets-liabilities ratio, while profitability measure was
considered Return on Asset (ROA) ratio. However, this study is based on time series data extracted from
annual reports for the relevant six years period (from the 2006 to 2011).
To determine the nature and extent of the relationship, collected data were analyzed by employing
Correlation technique; regressions & descriptive statistics. A well-known statistical package like Statistical
Package for Social Sciences (SPSS) 16.0 Version was used in order to examine the data. Correlation
analysis technique is used to determine the nature and extent of the relationship, while regression analysis
technique is used to determine whether cause-and-effect relationship exists between liquidity and
profitability. Correlation coefficient is computed from liquidity and profitability ratios derived from six-year
financial statements of the selected banks.
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A. Akter & K. Mahmud

Simple linear regression model is used for empirical investigation and analysis of the relationship
between liquidity and profitability. The model has designed based on assumed dual functional relationship of
liquidity and profitability. The respective models theoretical version is profitability (PFTY) depends on
liquidity (LQTY). Functionally,
PFTY = f(LQTY) . I
From these functional relationship, the simple linear regression model below is specified.
PFTY = 0 + 1LQTY + II
Where 0 is the intercept of the regression lines and 1 is the slope coefficient to capture the nature and
effect of the relationship between the variables.
is the stochastic term depicting influence of other factors that affect liquidity and profitability but
which is not included in the model.
4. Results and Discussion
We have run the regression for different categories of bank. Then we also have run the regression for
the total banking industry of Bangladesh. So, results are presented into five categories.
Regression Analysis
Government Banks
Source |
SS
df
MS
-------------+-----------------------------Model | 6.9715e-06
1 6.9715e-06
Residual | .000295723
14 .000021123
-------------+-----------------------------Total | .000302694
15
.00002018

Number of obs
F (1,
14)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

16
0.33
0.5747
0.0230
-0.0468
.0046

-----------------------------------------------------------------------------roa |
Coef.
Std. Err.
t
P>|t|
[90% Conf. Interval]
-------------+---------------------------------------------------------------cr | -.0021932
.0038177
-0.57
0.575
-.0089173
.0045309
_cons |
.0106247
.0043217
2.46
0.028
.0030129
.0182364
------------------------------------------------------------------------------

R-square is 2.30%. P-value is 0.575 > 0.10, which means at 90% level of significance there is no
significant relationship between current ratio (CR) and return on asset (ROA).
Private Commercial Banks
Source |
SS
df
MS
-------------+-----------------------------Model | 2.7477e-06
1 2.7477e-06
Residual | .000365857
16 .000022866
-------------+-----------------------------Total | .000368604
17 .000021683

Number of obs
F (1,
16)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

18

0.12
0.7334
0.0075
-0.0546
.00478

-----------------------------------------------------------------------------roa |
Coef.
Std. Err.
t
P>|t|
[90% Conf. Interval]
-------------+---------------------------------------------------------------cr | -.0017218
.0049669
-0.35
0.733
-.0103934
.0069499
_cons |
.0156689
.0051008
3.07
0.007
.0067635
.0245744
------------------------------------------------------------------------------

R-square is 0.75%. P-value is 0.733 > 0.10, which means at 90% level of significance there is no
significant relationship between current ratio (CR) and return on asset (ROA).
Islamic Banks
Source |

SS

df

MS

Number of obs

= 16

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International Journal of Empirical Finance

-------------+-----------------------------Model | .000034757
1 .000034757
Residual | .000627563
14 .000044826
-------------+-----------------------------Total | .000662319
15 .000044155

F (1,

14)
= 0.78
Prob > F
= 0.3934
R-squared
= 0.0525
Adj R-squared = -0.0152
Root MSE
= .0067

-----------------------------------------------------------------------------roa |
Coef.
Std. Err.
t
P>|t|
[90% Conf. Interval]
-------------+---------------------------------------------------------------cr |
.061054
.0693363
0.88
0.393
-.0610688
.1831768
_cons | -.0488129
.0755046
-0.65
0.528
-.1817999
.0841741
------------------------------------------------------------------------------

R-square value is 5.25%. P-value is 0.393 > 0.10, which means at 90% level of significance there is no
significant relationship between current ratio (CR) and return on asset (ROA).
Multinational Banks
Source |
SS
df
MS
-------------+-----------------------------Model | .000159264
1 .000159264
Residual | .002839976
16 .000177498
-------------+-----------------------------Total |
.00299924
17 .000176426

Number of obs
F (1,
16)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

18
0.90
0.3576
0.0531
-0.0061
.01332

-----------------------------------------------------------------------------roa |
Coef.
Std. Err.
t
P>|t|
[90% Conf. Interval]
-------------+---------------------------------------------------------------cr |
.0206745
.0218259
0.95
0.358
-.0174311
.05878
_cons | -.0050405
.0222591
-0.23
0.824
-.0439023
.0338212
------------------------------------------------------------------------------

R-square is 5.31%. P-value is 0.358 > 0.10, which means at 90% level of significance there is no
significant relationship between current ratio (CR) and return on asset (ROA).
Overall Banking Industry
Source |
SS
df
MS
-------------+-----------------------------Model | 1.5144e-07
1 1.5144e-07
Residual | .005139561
66 .000077872
-------------+-----------------------------Total | .005139712
67 .000076712

Number of obs
F (1,
66)
Prob > F
R-squared
Adj R-squared
Root MSE

=
=
=
=
=
=

68
0.00
0.9650
0.0000
-0.0151
.00882

-----------------------------------------------------------------------------roa |
Coef.
Std. Err.
t
P>|t|
[90% Conf. Interval]
-------------+---------------------------------------------------------------cr |
.0002293
.0052005
0.04
0.965
-.0084465
.0089051
_cons |
.0137338
.0055405
2.48
0.016
.0044908
.0229768
------------------------------------------------------------------------------

R-square is 0.00%. P-value is 0.965 > 0.10, which means at 90% level of significance there is no
significant relationship between current ratio (CR) and return on asset (ROA).
From all the regressions, we can see that there is no significant relationship between liquidity (CR) and
profitability (ROA) in all types of banks and even in the overall banking industry in Bangladesh.
Correlation Analysis
We also tried to look at the correlation coefficient between liquidity (CR) and profitability (ROA).
Correlation between these factors to look at the direction of relationship, if there is any.
Government Banks

|
roa
cr
-------------+------------------

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A. Akter & K. Mahmud

roa |
cr |

1.0000
-0.1518

1.0000

Correlation coefficient between return on asset and current ratio for government banks is negative and
very weak.
Private Commercial Banks

|
roa
cr
-------------+-----------------roa |
1.0000
cr | -0.0863
1.0000

Correlation coefficient between return on asset and current ratio for private commercial banks is also
negative and the strength of association is weaker than government banks.
Islamic Banks

|
roa
cr
-------------+-----------------roa |
1.0000
cr |
0.2291
1.0000

Correlation coefficient between return on asset and current ratio for islami banks show positive
relationship and in this case the relationship is also weak but moderately better than the other two types of
banks.
Multinational Banks

|
roa
cr
-------------+-----------------roa |
1.0000
cr |
0.2304
1.0000

Correlation coefficient between return on asset and current ratio for multinational banks show positive
relationship and in this case the relationship is almost same as islami banks.
Overall Banking Industry

|
roa
cr
-------------+-----------------roa |
1.0000
cr |
0.0054
1.0000

For overall banking industry, correlation coefficient between return on asset and current ratio shows
almost no relationship. Although multinational and islami banks show positive correlation coefficient, there
are no significant relationships between liquidity and profitability.
5. Discussion of Results
These results reveal that there is no significant relationship exists between liquidity and profitability in
all the categories on banks in Bangladesh. Even as a total industry there is no significant relationship
between liquidity and profitability. Definitely liquidity has impact on short-term operations of any firm. But
for banking industry in Bangladesh, it shows there is no significant impact of liquidity on profitability. All
our analyses show that all the models can explain very small amount of dependency with no significance at
10% level of significance.

148

International Journal of Empirical Finance

1.6
1.4

Government Bank

1.2
1

Islami Bank

0.8
Pvt Commercial
Bank

0.6
0.4

Multinational

0.2
0
2006

2007

2008

2009

2010

2011

Figure 1: Current ratio of different types of banks in Bangladesh from 2006 to 2011
We also plotted the data of current ratio of different bank categories of Bangladesh from 2006 to 2011.
Figure 1 shows the pattern. Islami banks show a steady current ratio over the years. Multinational banks and
Private commercial banks also show steady current ratio. On the other hand, government banks show more
variability in current ratios over that period of time. But profitability tells us a different story (fig. 2). Return
on Asset of all these categories of banks show similar amount of variability over the same time period. This
also explains no significant relationships between liquidity and profitability in banking industry of
Bangladesh.
2.50%
2.00%
Government Bank

1.50%

Islami Bank

1.00%

Pvt Commercial Bank

0.50%

Multinational

0.00%
2006 2007 2008 2009 2010 2011

Figure 2: Return on Asset of different types of banks in Bangladesh from 2006 to 2011
6. Conclusion
Our analysis has shown the degree of relative relevance of liquidity and profitability in the four sectors
of banks in Bangladesh. From the analysis, we can say that there is no significant relationship between
liquidity (measured as current ratio) and profitability (measured as return on asset) in these banks. Still,
liquidity is very important for any institutions and profitability shows the financial strength of that institution.
Liquidity shows the strength of the banks in terms of their operations and profitability shows their effective
and efficient value maximization over the period of time. In our future work, we will look into other
variables to look at how they can explain profitability more. We also will expand our study horizon to
different industry and will try to show a comparative analysis.

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