Factors Affecting Commercial Bank Liquidity in Ethiopia: An Empirical Study of Selected Commercial Banks

Imagine a bank not as a vault of gold, but as a busy river system. On one side, water flows in from the hills of savings and deposits; on the other, it rushes out to irrigate the fields of loans and investments. The river must always have enough water to satisfy those who come to the bank to withdraw their money, even if the demand comes suddenly. This balance is called liquidity. It is the ability of a bank to pay its bills and honor withdrawals without having to sell its assets at a loss or borrow money at a crushing cost. If the river runs dry, the bank fails, and the people who trusted it with their savings lose everything. If the river is too full, however, the bank misses out on the chance to grow, because money sitting idle earns very little. Finding the perfect flow is the daily challenge for bank managers everywhere, but in Ethiopia, the specific forces that push and pull this river have remained somewhat unclear.

A researcher named Derbew Dagnew from the University of Gondar set out to map these currents. He looked at eleven commercial banks operating in Ethiopia over a ten-year period, stretching from the 2014/15 fiscal year to 2023/24. By examining the annual financial records of these institutions alongside the broader economic data of the country, he sought to understand exactly what makes a bank's liquidity rise or fall. He treated the banks like a single, evolving ecosystem, tracking how changes in their own internal health and the external economic weather influenced their ability to keep their cash reserves safe and ready.

The study began by looking at the banks' own internal strengths. One of the most powerful forces Dagnew found was the amount of capital a bank held. Capital acts as a cushion, a buffer of safety that allows a bank to absorb unexpected losses without panic. The data showed a clear, positive link: banks with stronger capital cushions were better able to maintain their liquidity. When a bank has more of this safety net, it can afford to keep more liquid assets on hand, reassuring depositors that their money is secure. This finding supports the idea that a well-capitalized bank is a resilient bank, capable of weathering storms without running out of water.

Another critical factor was the act of gathering deposits. When a bank successfully attracts more money from savers, its liquidity improves. The research confirmed that as deposit mobilization increased, the banks' ability to meet their obligations grew stronger. It seems that a steady, growing stream of deposits provides a reliable foundation, allowing banks to lend money with confidence while still keeping enough cash in reserve to handle daily withdrawals. This suggests that the relationship between a bank and its customers is fundamental; a bank that is good at keeping its customers happy and their money safe is also a bank that is financially liquid.

However, the river does not always flow smoothly. The study discovered that when banks grow their loan books too quickly, their liquidity tends to shrink. Loans are like water that has been diverted into irrigation channels; once the money is lent out, it is no longer sitting in the bank's vault waiting to be withdrawn. The data showed a significant negative relationship between the speed of loan growth and liquidity. As banks rushed to lend more money, they used up their available cash, leaving them with less immediate flexibility. This is a classic trade-off in banking: the more you lend, the less liquid you become, because loans are harder to turn back into cash quickly than deposits are.

The broader economic environment also played a decisive role. The study found that when the country's money supply increased, bank liquidity actually decreased. This might seem counterintuitive, as one might think more money in the system would mean more money for banks. Instead, the expansion of money supply appeared to encourage banks to lend more aggressively, shifting their funds from safe, liquid assets into loans and investments. Similarly, when the economy was growing rapidly, banks tended to become less liquid. During economic booms, the demand for borrowing is high, and banks respond by lending out their reserves to capture the opportunity, which naturally lowers the amount of cash they hold on hand.

Interestingly, the study ruled out several factors that many people might assume are important. The research found no strong evidence that a bank's profitability, its sheer size, or the difference between the interest rates it charges and pays had a significant impact on its liquidity. While it is logical to think that a more profitable bank would be more liquid, or that a larger bank would have different needs, the data from these Ethiopian banks did not support those ideas. The results were also inconclusive regarding the impact of holding government bills, the rate of inflation, or the specific interest rate margins. These factors did not show a clear, consistent pattern in the data, suggesting that in this specific context, they are not the primary drivers of liquidity.

The implications of these findings are practical and direct. For bank managers, the message is that maintaining a strong capital base and focusing on stable deposit gathering are the most reliable ways to ensure liquidity. They must also be careful not to let their lending grow so fast that it drains their cash reserves, especially during times when the economy is booming and the central bank is expanding the money supply. For the regulators, the National Bank of Ethiopia, the study suggests that policies should consider how capital requirements and credit growth interact with the broader economy. A bank that is too eager to lend during a good economic period might find itself short of cash when the winds change.

Ultimately, this research paints a picture of Ethiopian banking as a system driven by a few key levers. The ability to stay liquid depends less on how much profit a bank makes or how big it is, and more on how well it is capitalized, how steadily it gathers deposits, and how carefully it manages the pace of its lending against the backdrop of the national economy. By understanding these specific dynamics, bank leaders can navigate the river of finance with greater skill, ensuring that the water always flows where it is needed, without ever running dry.