The Liquidity-Profitability Trade-off: Empirical Evidence from Listed Deposit Money Banks in Nigeria

Abstract

This study investigated the liquidity-profitability trade-off among listed Deposit Money Banks in Nigeria. The main objective was to examine the impact of liquidity transformation and asset holding on corporate financial performance. Specifically, the study analyzed the baseline profitability trends; determined the effect of the Liquidity Ratio (LIQ) on Return on Assets (ROA); assessed the impact of the Loan-to-Deposit Ratio (LDR) on ROA; and evaluated the influence of institutional controls such as the Capital Adequacy Ratio (CAR) and Bank Size on overarching financial performance.
The study adopted an ex-post facto and longitudinal panel research design. Balanced panel data covering a ten-year period from 2015 to 2024 were sourced from the audited annual financial statements of twelve (12) purposively selected listed banks and the Central Bank of Nigeria. Data were analyzed using descriptive statistics, Levin-Lin-Chu unit root tests, Kao Residual Cointegration tests, Hausman specification tests, and Panel Estimated Generalized Least Squares (EGLS) regression. All hypotheses were tested at the 0.05 level of significance.
Results from the Panel EGLS (Cross-section Random Effects) regression showed that the Liquidity Ratio had a statistically significant negative impact on profitability (β = -0.0227, p = 0.0212), explicitly confirming the trade-off theory. Conversely, the Loan-to-Deposit Ratio had a positive but statistically insignificant effect on ROA (β = 0.0026, p = 0.7314). The overarching model yielded an R2 = 0.3308. Furthermore, the regression established that both the Capital Adequacy Ratio (β = 0.0971, p = 0.0049) and Bank Size (β = 0.5664, p = 0.0003) exerted highly significant positive impacts on financial performance.
The study concluded that a strict, inverse liquidity-profitability trade-off dictates the Nigerian banking ecosystem, where holding excessive liquid assets systematically destroys shareholder wealth, while forced credit expansion without pristine asset quality proves to be an inefficient profit strategy. Recommendations include abandoning overly conservative cash-hoarding behaviors to rapidly deploy excess liquid reserves into higher-yielding investments, prioritizing rigorous credit risk management over mere loan volume expansion, and actively pursuing sector consolidation to achieve profitability-maximizing economies of scale.