Introduction
Background of the study
Risks are everyday natural anticipated events in business and community settings that may have a detrimental impact on an individual or institution if not well managed. In particular, in the banking sector, Agoraki, Delis, and Pasiouras (2011) observed that risks are conditions that might escalate the chances of loss or gain and are uncertain thus holds the potential to manipulate the financial performance of a bank and other financial institutions. Therefore, there is a need for the establishment or adoption of risk management practices (RMPs) that would be instrumental in reducing banks’ exposure to risks. Financial liquidity is an elusive concept yet of significant importance in determining any given economic system (Vodovà 2013). Moreover, according to Hakimi and Zaghdoudi (2017), prudent management of liquidity is paramount in determining the financial institutions’ performance in a country, region or the entire world. On the other hand, liquidity risk is the possibility that the bank will be unable to meet its financial obligations in the future with immediacy without suffering a considerable loss.
Arif and Anees (2012) opined that liquidity risks are detrimental to the banks’ financial performance and have a significant negative impact on the firm’s reputation.
Wójcik-Mazur and Szajt (2015) opined that the financial sector faces various liquidity risks, which have been linked to lack of proper asset and liability management and to some extent, the financial volatility markets. According to Chortareas, Girardone, and Ventouri (2011),
liquidity risks emanate from various factors, including the inability of the banks to balance their currents assets against current liabilities effectively. However, in the recent studies, it has been revealed that despite the efforts by a financial institution to manage their liquid assets prudently, they have experienced a degree of liquidity risks resulting from the global economic crises the most recent one being the 2007-2009 depression (Ibrahim, 2018).
The European banking industry had been initially hit by the global financial crisis of 2007-2009 but is considered to have been recovering slowly but steadily (Ly, 2015). Natural calamities also play a crucial role in enhancing liquidity risks with the recent global COVID-19 pandemic being predicted to have a potential impact on banks’ financial well-being due decline in consumption of financial services and low performance of existing loans.
Problem statement
Banks’ financial performance is a crucial determinant of economic health in a country or region and hence need to be monitored closely. The 2007-2009 financial crisis had significantly hit the European banking sectors, and despite recovering from this problem, the effects are still felt among various banks in the region (Ibrahim, 2018). Moreover, the COVID-19 pandemic and the related restrictions have adversely affected banks’ operations in Europe and the rest of the world. Due to the increasing volatility of the financial sector and the uncertainties in the banking industry, there is a higher probability that banks might fall into a liquidity crisis (International Monetary Fund, 2011). In the 2011-2019 period, the various events such as global pandemic and the effects of previous economic crisis might have escalated the chances of liquidity risks among European banks, which might harm the financial performance (Vodovà 2013). However, the exact repercussion of this liquidity risk on European banks’ profitability has not been examined in the 2011-2019 period hence the need for a study to establish if there was a relationship between liquidity risk and financial performance in European banks.
Significance of the study
The findings of the current study will be of significance to the managers of various banks in Europe as they will use the established correlation to determine whether to apply stringent measures to reduce chances of liquidity risks or not. Moreover, regulatory bodies such as the Federal Bank of the European Union, European Central Bank and the European Banking Authority might find the study’s findings useful in setting their regulatory measures for banks in the industry.
Research aim
The current research will aim at establishing the link between financial liquidity risks experienced in the banking sector in Europe to the financial performance of these firms between 2011 and 2019.
Research objectives
1. To examine the trend and current status of financial liquidity in the European banking sector between 2011 and 2019.
2. To examine the trend and current financial performance (profitability) in the European banking sector.
3. To establish the relationship between the liquidity risks and the financial performance using the European banking sector’s case between 2011 and 2019.
Research questions
1. How has the sector faired in managing financial liquidity issue in the European banking sector?
2. Is there a significant change in financial performance among banks in Europe between 2011 and 2019?
3. Is there a correlation between liquidity risks and performance in the banking sector?
Research hypothesis
There is a significant negative relationship between financial liquidity risks and performance in the banking industry.
Literature Review
Introduction
Liquidity is an essential element in a financial institution’s operations and, therefore, should be appropriately managed and monitored to prevent the organisation from experiencing difficulties in meeting its immediate financial obligations (Ibrahim, 2018). This section highlights the work that has been previously done by various scholars on topics related to the current research.
The concept of liquidity risk and financial performance
Arif and Anees (2012) defined a liquidity risk as an uncertain event that results from the firm’s inability to liquidate its assets for the desired price timely. From this definition, it is apparent that there two primary aspects of liquidity risk, namely liquidation of assets and the price value of disposing such assets at the right time. One of the sources of liquidity risk is a mass withdrawal of commercial banks’ funds (Munteanu, 2012). However, Agoraki, Delis, and Pasiouras (2011) observed other causes of liquidity risks apart from deposits withdrawal. They cited economic crisis and long-term lending as factors that may cause a massive liquidity crisis for financial institutions.
According to Munteanu (2012), there are two liquidity risk components, namely the maturity transformation and inherent liquidity of the bank’s assets. Maturity transformation is referred to duration taken by the bank assets to mature and liability to fall due; consequently, inherent liquidity is the bank’s ability to sell its assets without incurring loss at any given market condition (Munteanu, 2012).
In a study to examine the impact of liquidity risk on a bank’s financial performance, Chortareas, Girardone, and Ventouri (2011) observed that liquidity constraints might adversely affect the profitability and capital of a bank in extreme circumstances may lead to the collapse of the institution. According to Agoraki, Delis, and Pasiouras (2011), banks tend to borrow from the market at very high-interest rates to meet their immediate financial obligations, thus reducing the return on investment during a liquidity crisis. Moreover, liquidity risks may make a bank liquidate its assets at lower values to meet the depositors’ demand for cash, which lowers the firm’s capital base.
Methodology
The study will adopt a quantitative secondary approach in examining the correlation between liquidity risks and banks’ financial performance. This method is considered to be the most suitable for this study because it saves time that could have been used in designing and conducting a primary survey.
Additionally, quantitative secondary approach allows the researcher to obtain a pool of data in a single organisation or document thus reducing the expenses associated with the primary techniques such as interviews. The approach will also facilitate comparison between data from various banks included in the report.
The secondary data will be obtained from the annual reports prepared by the financial regulatory bodies in Europe, including those by the Federal Bank of the European Union, European
Central Bank and the European Banking Authority. Consequently, there will be a need to contact these organisations in advance to facilitate access to the information required especially for the data that is not available in the public domain. However, gaining access to these organisations might be challenging due to the sensitivity of some of the information required for the study, therefore, it will be necessary to have a prior communication from the university.
The study will employ a positivists’ philosophy in which the knowledge is constructed from the observable and measurable aspects of the phenomenon of interest. This philosophy will facilitate the accuracy of the data analysis and avoid any chance of biasness. The data obtained will be analysed using SPSS due to its availability and ease to use. The analysis will generate both inferential and descriptive statistics. Inferential statistics will be crucial in depicting the correlation while descriptive statistics will provide an insight into the trends in performance of the banking sector in Europe.
Foreseeable limitations of the study
Since the research will depend primarily on secondary data, the results will be based on past scenarios, thus not depicting the banking sector’s present situation. Furthermore, the current study inherits the mistakes made in data collection by the primary survey; this may compromise the validity of the findings.
Research Schedule
Activity Duration
Identification of research topic and formulation of the interim proposal 21st November 2020 10th December 2020
Drafting and approval of the final research proposal 11th December 2020 to 13th January 2021
Extensive literature review on the topic 14th January 2021 to 15th February 2021
Data collection and analysis and presentation 16th February 2021 to 18th March 2021
Defence of the research findings 19th March 2021 to 26th March 2021
Preparation of the final research project report/ thesis document 27th March 2021 to 20th April 2021