The Relationship Between Liquidity Risk and Performance : An Empirical Study of Banks in Europe 2005-2010

University essay from Umeå universitet/Handelshögskolan vid Umeå universitet (USBE); Umeå universitet/Handelshögskolan vid Umeå universitet (USBE)

Author: Jonattan Toutou; Xu Xiaodong; [2011]

Keywords: ;

Abstract:

Recent financial shocks have generated a lot of debates over the issue of liquidity risk and strategies to mitigate its effects on financial institutions, particularly banks as majors’ players in the funding liquidity markets. The topic is controversial as contradictory views from different researchers have not reached any consensus. With this at hand, the purpose of this research is to investigate whether there is any relationship between liquidity risk and banks performance in the Eurozone area during the periods 2005-2010.We have selected a sample of 12 banks from the EUROSTOXX index based on their market capitalization from different countries in the Eurozone. We explored their websites for an apprehension of their half a year financial reports from 2005-2010. For a clearer understanding of the analysis, we have used loan to assets, loan to deposit and cash position as liquidity risk ratios, and for measuring banks performance we have used Return on Assets, Return on Equity, Net Profit Margin and Net Interest Margin as profitability ratios while Debt to Asset and Debt Leverage were used as stability (Risk& Solvency) ratios. Descriptive statistics were performed to explain the behavioral pattern of liquidity position for each bank and their performance ratios.We have the used the regression analysis to test for the dependency and correlation. We applied the test-statistics to estimate the coefficients to find out if there exists any relationship between liquidity risk indicators and bank performance measures with results significant at the 5%level. We equally used F-test as a combined tests statistics to analyze the variance with results significant at the 5% level.Results reveal that there is potential statistical evidence to infer that there is a linear relationship between Debt Leverage, Debt to Asset and liquidity risk indicators, contrary to the results of bank profitability ratios which F-values disclose mixed effect relationship with some ratios positively related to liquidity risk indicators while others displaying a negative relationship.Based on this mixed effect relationship, we cannot firmly conclude that there exist a relationship between liquidity risk indicators and bank performance measures.

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