This paper makes an attempt to study the effect of liquidity management on the profitability of public and private sector banks in India. For this purpose, 27 public sector banks and 20 private sector banks have been considered for the periods 2011-12 and 2015-16. Cash-Deposit Ratio (CDR), Credit-Deposit Ratio (CRDR) and Investment-Deposit Ratio (IDR) have been used as independent variables to denote the liquidity management of the banks, while Return on Assets (ROA) and Return on Equity (ROE) have been used as proxy variables for the profitability of the banks. It is found that there is a significant negative effect of CDR and IDR on ROA. However, in the case of ROE, it is found that there is no significant relationship between banks’ profitability and liquidity taking all the variables into consideration, irrespective of the type or form of commercial banks in India. This leads to the conclusion that the commercial banks can focus on increasing their profitability without affecting their liquidity and vice versa.

The trade-off between liquidity and profitability has been a burning issue in the corporate world. Theoretically, both liquidity and profitability are affected by the working capital decisions of any company. Excess of investment in working capital may result in low profitability and lower investment may result in poor liquidity. Therefore, the management needs to trade off between liquidity and profitability to maximize shareholders’ wealth. Every organization, whether profit-oriented or not, irrespective of size and nature of business, requires necessary amount of working capital. Working capital is the most crucial factor for maintaining liquidity, survival, solvency and profitability of business (Mukhopadhyay, 2004). It is observed that if a firm wants to take a bigger risk for mammoth profits, it minimizes the dimension of its working capital in relation to the revenues it generates. If it intends to improve its liquidity, that in turn raises the level of its working capital. Nonetheless, this technique might tend to reduce the sales volume and consequently, it would affect the profitability. Thus, a company needs to have a striking balance between liquidity and profitability. In order to maintain high profitability levels, companies might need to forfeit their solvency by maintaining relatively low levels of current assets. As soon as the companies start doing so, their profitability would improve as less amount of money is fastened up to the idle current assets and their solvency would be in danger. Therefore, excessive levels of current assets may have a negative effect on the firm’s profitability, whereas a low level of current assets may lead to lower level of liquidity and stock outs, resulting in difficulties in maintaining smooth operations (Van and Wachowicz, 2004).