Liquidity Regulation and Bank Performance: Evidence from Nigeria

Abstract

This study examined the effect of liquidity regulation on the performance of commercial banks in Nigeria over the period 1990 to 2025. The specific objectives were to ascertain the effect of liquidity regulation on bank profitability, operational efficiency and market valuation, proxied respectively by Return on Assets (ROA), Cost-to-Income Ratio (CIR) and Market Capitalisation (MCAP). Liquidity regulation was measured using the Liquidity Ratio (LR) and the Loan-to-Deposit Ratio (LDR). Anchored on the Liquidity Preference and Liability Management theories, the study adopted an ex post facto research design and employed the Autoregressive Distributed Lag (ARDL) bounds testing approach to cointegration, given the mixed order of integration of the variables. Secondary time-series data were sourced from the Central Bank of Nigeria (CBN) Statistical Bulletin, CBN Financial Stability Reports and the Nigerian Exchange Group. The findings revealed that the Liquidity Ratio exerted a positive and statistically significant long-run effect on profitability and a negative significant effect on the Costto-Income Ratio, indicating that stronger liquidity buffers enhanced both earnings and operational efficiency. Conversely, the Loan-to-Deposit Ratio had a negative significant effect on profitability and a positive significant effect on the Cost-to-Income Ratio, suggesting that aggressive credit expansion relative to the deposit base eroded performance. The bounds test confirmed a long-run cointegrating relationship between liquidity regulation and market valuation; however, the individual coefficients of LR and LDR on MCAP were statistically insignificant, implying that investor valuation in Nigeria is driven more by profitability and macroeconomic conditions than by liquidity indicators. The study concluded that liquidity regulation is a significant determinant of bank profitability and efficiency but a weak direct driver of market valuation. It was recommended, amongst others, that the CBN should periodically recalibrate the minimum liquidity ratio in line with macroeconomic conditions, and that bank managers should adopt dynamic asset-liability management frameworks to balance regulatory compliance with profitability objectives.