Bank performance and liquidity management

This paper investigates bank liquidity management and its effect on bank performance. Commercial bank’s balance the tradeoff between holding liquid assets and investing in risky assets to maximize profits. Holding more liquid assets lowers the liquidity risk of banks, but it also increases their operation costs and likely lowers their profits. Therefore, we hypothesize that a bank’s liquidity management policy matters for bank performance. We analyze bank data from Call Reports from 1990 to 2020. We compute a comprehensive liquidity measures and estimate the adequate liquidity level for each bank as the basis for evaluating the liquidity management of a bank. We show that banks that maintain an adequate liquidity ratio tend to experience better operating performance, greater stability, and lower bankruptcy risk. We also investigate the effect of bank liquidity management under different economic conditions. Our study highlights the importance of bank liquidity management.