The Information Content of Bank Liquidity: An evaluation of links between banks ’ liquidity ratios and financial performance

Abstract: Background and problem: Since the financial crisis of 2007-2008, it has been widely argued that part of the banking crisis was due to bad liquidity management by the banks themselves. An example of this ongoing discussion is the new increased liquidity requirements of the upcoming Basel III regulation. This discussion raises the question if accounting data on bank liquidity has any information content, and if it is in fact related to the performance of banks. Purpose: The objective of this study is to evaluate the relation between liquidity accounting ratios and financial performance in the banking sector, and thereby assess the usefulness and information content of said ratios. This will be done by testing whether banks’ different liquidity ratios are significantly related to their performance indicators in the same period. Coverage: The study covers accounting data and stock market data from the years of 2005-2012. The study includes listed banks that originate from the US and the EU, with total assets greater than USD 1 billion. Method: The study has been designed as an explanatory, deductive, and positivistic study. The main method used has been multivariate regression analysis, and through this hypotheses have been tested by studying the coefficients from the regression output. Findings: The findings of the study indicate that a bank’s liquidity level is significantly related to its stock returns in the same period, in line with the hypotheses. Further, one of the chosen liquidity ratios is related to the return on equity of banks, also in line with the hypotheses. This could indicate some links between liquidity ratios and financial performance. Suggestions for further research: Include more geographical areas. Compare different accounting standards. Apply the study to other industries. Conduct a predictive study testing the predictive ability of liquidity, based on the findings that the variables are indeed related in the same period. Limitations: Findings are only applicable to banking industry. Assumptions on causality and accounting standard similarity made. Control variables are limited.