The effects of liquidity and solvency on South African banks’ performance

Abstract

This study examined the effects of liquidity and solvency on South African banks’ performance. The panel regression approach was used, applying panel data from 13 commercial banks over the period 2012 to 2022. The pooled ordinary least squares regression, fixed effects, random effects, and generalised methods of moments were used in the liquidity ratio, solvency ratio and bank performance regression analysis. However, the strategy using system-generalised methods of moments was chosen above the others since it resolved the endogeneity issue. The relationship between liquidity, leverage and bank performance was investigated due to fewer research made in the South African context especially the banking sector. Moreover, South African Banking sectors has gone through some interesting developments post-Apartheid era. Thus, the research's main objective is to build on past research on the South African banking context for a relationship between liquidity, leverage, and bank performance. There were contradictions on the relationship between liquidity and leverage and performance. Moreover, rarely was this phenomenon empirically tested in South African banks. Theory and a significant portion of empirical studies suggest a negative relationship between solvency and performance. While on the other hand theory postulates both negative and positive relationship between liquidity and bank performance. The study had three objectives. The first being an examination of the relationship between liquidity coverage ratio and bank performance in South Africa. The second being to investigate the relationship between the net stable funding ratio and bank performance in South Africa. And the last being to examine the relationship between leverage and bank performance in South Africa. The empirical findings indicate that the bank independent variables (liquidity and leverage) have diverse effects on bank performance, with liquidity having a negative impact. Leverage, on the other hand, had both positive and negative impacts on bank profitability. The results imply that leverage can be a double-edged sword that managers should carefully monitor as it is dependent on what you want to achieve. Also, though liquidity is a cost at it negatively affects performance it can equally enhance performance if the banks can optimise its management by taking advantage of ad hoc profitable projects. Future studies should investigate the impact of a pandemic like COVID-19 and digital disruptions on bank performance.