The Nexus between Liquidity and Credit Risks and Their Impact on Bank Stability

Abstract

This study examines the nexus between liquidity and credit risks and their impact on bank stability in Nigeria. In order to achieve the research objectives, this study utilizes secondary data, which covers 12 Nigerian banks from 2010 to 2021. The Generalized Method of Moment (GMM) was estimated using the Arellano and Bond estimation technique. The results revealed that credit and liquidity risks negatively and significantly impacted bank stability individually and jointly in Nigeria. Furthermore, we deduced a positive correlation between credit and liquidity risks, with the correlation result statistically significant. Further investigation using the Pairwise Dumitrescu-Hurlin Panel Causality Tests indicated a one-way (uni-directional) causality from liquidity to credit risk. Further analysis showed that other internal bank-related indicators significantly impact bank performance. Bank Size, Equity, and Capital Adequacy positively and significantly impact bank performance. Likewise, macroeconomic indicators such as economic growth positively and significantly impact bank performance. In contrast, the inflation rate has a negative but insignificant impact on bank stability in Nigeria. Based on the findings, the study recommends joint management of credit and liquidity risks since a rise in liquidity risk will increase credit risk, resulting in bank instability. Thus, the results support bank regulation emphasizing the reduction of credit and liquidity risks in the banking sector since credit and liquidity risks have an attendant adverse effect on bank stability. The study will help bank managers balance liquidity, profit maximization, and risk minimization.