Univerzitet u Istočnom Sarajevu, Ekonomski fakultet Brčko University of East Sarajevo, Faculty of Economics Brcko Zbornik radova Ekonomskog fakulteta Brčko Proceedings of Faculty of Economics Brcko http://zbornik.efb.ues.rs.ba Časopis Ekonomskog fakulteta Brčko Volumen 17, Sveska 1, 2023, str. 25-31 Journal of Faculty of Economics Brcko Volume 17, Issue 1, 2023, pp. 25-31 Klasifikacija Originalni naučni članak Classification Original scientific paper UDK: 005.336.4:336.71(497.6РС) DOI: 10.7251/ZREFB2317025K LIQUIDITY IMPACT ON BANKS PROFITABILITY IN THE REPUBLIC OF SRPSKA Srđan Kondić a1 , Saša Stevanović b2 a Addiko Bank a.d. Banja Luka, Banja Luka, Bosnia and Herzegovina b Management company of The Pension Reserve Fund Of Republic of Srpska ad Banja Luka, Banja Luka, Bosnia and Herzegovina ARTICLE INFO Received 12/11/2023 Sent to revision 12/12/2023 Accepted 12/18/2023 Available online 12/27/2023 Keywords: Liquidity Profitability Solvency Model Interest cost ABSTRACT Banks, as the primary goal have profit maximization, but because of its importance for the overall economic system there is a huge number of stakeholders from depositors to government who are vitally interested in how banks operate, i.e. maximize profits. Our aim is to establish and examine relationship between banks profitability and liquidity. We will look at 16 interdependencies between liquidity indicators: liquid assets by total assets, liquid assets towards short-term financial liabilities on the one hand and profitability indicators: returns on average assets, return on average capital, net interest income according to total income, non-interest expense according to the total income etc. We constructed solvency model for banks in the Republic of Srpska according to factors which are mostly correlated on state level. We used the data available for the banking system of Republika Srkska to form the model. The model captures 70% of linear relationship between predictor variables and response variable. We can conclude that significant variables are interest cost, capital to asset ratio, dividends, and membership to a group. However, our model caputre 70% of relationship and give us satisfactory level to conduct politics in order to increase bank profitability and creditworthines. Introduction Banks, as well as all other economic entities, as the primary goal have profit maximization, but because of its im importance for the overall economic system there is a huge number of stakeholders from depositors to government who are vitally interested in how banks operate, i.e. maximize profits. Liquidity policy management cannot be separated from management in other bank business segments, and in particular from profitability management with which it is in reverse relationship. Theoretically and practically in banking, achieving the target rate of profitability implies balancing among other fundamental principles of banking activity (liquidity, solvency, capital adequacy and risk mitigation, risk appetite, etc.). According to empirical facts, the business of banks is based on security, liquidity and profitability principles, in that order, because only a liquid and stable bank can perform its target function and maximize shareholder profits in a sustainable way. The theoretical ratio of liquidity and profitability is a "zero-sum game": higher liquidity entails a lower profit potential, while lower liquidity implies a higher earning capacity of the bank, therefore, according to the principle of causality, a bank that does not respect the principle of liquidity threatens the target function of profitability. Unlike capital regulation which was always in extensive focus both regulators and academic scrutiny, liquidity regulation is new and has run ahead of research (Diamond & Kashyap, 2016). These authors emphasize that when it comes to liquidity regulation we do not even know what to argue about. The research we conducted aims to contribute to the clarification of the liquidity and profitability relationship in the Republic of Srpska and give new evidence for this phenomenon. Paper of Adelpo et al. (2022) 1 konda1982@icloud.com 2 sasabn@gmail.com