Liquidity Risk And Its Impact On Banks Profitability In Kyrgyzstan

The study surveys the determinants of liquidity risk of banks in the territory of Kyrgyz Republic and its effect on banks profitability.Theory on the effects of liquidity risk on bank profitability is mixed;while some works determine that high liquidity risk increases earnings of bank due to the high net interest margins,other studies conclude that it dampens profitability because of the high cost associated.In addition,the study uses an unbalanced data set of 11 banks over the period 2008-2014.Thus,to estimate the determinants of liquidity risk the random effects GLS regression based on the Hausman test is used.The instrumental variables regression using two-stage least squares(2SLS)approach is applied to estimate the impact of liquidity risk on bank profitability due to endogenous nature of liquidity risk as a determinant.To determine,the research employs the financing gap ratio(FG)as the measure of liquidity risk with bank size,square bank size,liquid assets ratio(less risky and risky liquid assets),external funding dependence,ownership type,inflation(annual percent of inflation and inflation percent change of inflation of last year)as the independent variables.The results of research show that the causes of liquidity risk include components of liquid assets and dependence on external funding,and macroeconomic factor like inflation.In order to ascertain the robustness of the results,the ratio of net loans to total deposits(NLD)as an alternative measure for liquidity risk is applied.Obtained results show that main determinants such as liquid assets and external funding dependence consistent with the results found from the use of financing gap ratio as a measure for liquidity risk.However,banks size,bank size square,and inflation(annual percent of inflation and inflation percent change of inflation of last year)showed insignificant statistics.In addition,findings of this study state that liquidity risk(both FG and NLD)may increase bank profitability measured by the return on assets(ROA).But,liquidity risk in the model where profitability measured by the return on equity(ROE)shows inconsistency with the results obtained from the ROA equation meaning that liquidity risk has no effect on the bank profitability.To conclude,the study suggests banks in the territory of Kyrgyz Republic should strengthen risk management to ensure a sound process for classifying,measuring,monitoring and controlling liquidity risk(and credit risk)in order to maximize bank profitability.