Bank’s Liquidity Holding And Profitability: Evidence From Generalized Method Of Moments

Abdul Malek, A. Tambi (2018) Bank’s Liquidity Holding And Profitability: Evidence From Generalized Method Of Moments. The Turkish Online Journal of Design, Art and Communication, 8 (S). pp. 1614-1623. ISSN 2146-5193

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Abstract

Aggressive bank financing operations can increase a bank’s profit. However, this operational approach exposes the bank to higher operational risk. Conversely, excessive holdings on liquidity offer safety, but it will reduce funds for financing and investment operations. Consequently, there is a trade-off between liquidity holdings and profitability performances. The objective of this study is to assess the implications of liquidity holdings on Islamic bank's profitability. This study utilized the dynamic panel data technique with Generalized Method of Moments (GMM) model applied to the annual data of Islamic banking institutions in Malaysia from 1998-2014. The estimation of which Return on Assets (ROA) and Return on Equity (ROE) is regressed on the liquidity holdings ratio. The result shows that the relationship takes the form of quadratic function with a downward concave parabolic due to the insufficient amount of fund. It suggests that profitability is improved for banks that hold some liquidity; however, it raises the issue in which holding further liquidity diminishes a banks’ profitability. There is a trade-off relationship between liquidity holdings and profitability performance given by both ROA and ROE. This finding is consistent with the idea that funding market reward banks for holding some liquid assets, but this benefit is somehow outweighed by the opportunity cost of holding such low-yielding assets. Hence, bank portfolio management should consider and develop strategy and liquidity plans that help balance the acceptable return and risks. A banking firm must determine the appropriate level of asset versus liability management in view of liquidity risk and associate trade off in terms of bank profitability.

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