Liquidity of Banks – Meaning, Significance and Principles
Liquidity: The term liquidity means the
capacity of the bank to give cash on demand. In other words, it is the ability
of the banker to satisfy the demand of customers for cash in exchange for
deposits. Liquidity depends on the availability of liquid assets. Liquid assets
are those assets which can be easily converted into cash without loss. More the
liquid assets, greater will be the liquidity and vice versa.
Composition of liquid assets: the liquid
assets of a bank are composed of the following:
1)
Cash in hand.
2)
Cash balance with other banks.
3)
Cash balance with other banks.
4)
Money at call and short notice.
5)
Investments.
6)
Advances.
Significance of liquidity: The term liquidity
has special significance in banking business. The deposits accepted by a bank
are largely payable on demand. In other words, the depositor has the right to
withdraw money as and when they needs. The banker must pay his depositors on
demand. In case a bank fails to pay cash on demand to the depositors on account
of shortages of liquid cash, it may lose the trust and confidence of the public
which will ultimately result in the closure of the bank. Thus, the banker must
safeguard his position by maintaining sufficient liquid assets with him to meet
the demand of the depositors for cash.
Factors
determining the cash balances or liquidity of a bank: The
following factors help the banks to decide the quantum of cash balances to be
maintained:
1) Banking
habit: Banking habits play a significant role in determining the cash balances
of a bank. Banking habits refers to the utilisation of banking services by the
public. If the people have e-banking habits then the use of cash in transaction
is reduced and the banks need to keep lesser amount of liquid cash.
2) Structure
of banking: The banking structure of the country also influence the liquidity
requirements of the bank. In a branch banking system, the banks can function
with less cash reserves because in case of emergency cash can be transferred
from one branch to another. Whereas in unit banking system higher cash reserve
is required.
3) Nature of
bank accounts: The nature of deposit accounts viz. savings, current or fixed
accounts affect the amount of cash balance to be kept by the banks. In case of
fixed deposit account holders, the bank can manage with less cash balance as
against current account where it must keep a larger cash balance.
4) Type of
depositors: The type of depositors is another determinant of cash balance of
the banks. If the majority of the depositors of the bank are business firms,
corporations, schools, college etc. the bank will have to maintain high
liquidity because of unpredictable. On the other hand, if the deposits are
mostly by individual customers and are of personal nature, the bank can operate
with less liquid cash.
5) Nature of
advances: The nature of advances of bank i.e. loans, cash credit, overdraft and
purchasing and discounting of bills also affect the size of the cash balances
of the bank.
6) Seasonal
requirements: The banks have to take into consideration the seasonal
requirements of credit from the customers. It is an established fact that
during busy seasons e.g. festivals, sowing, harvesting etc. seasons, there is
increased demand for credit. Hence, the banks should keep large amount of cash.
7) Nature of
business condition: The prevailing business condition in the country has its
influence on the cash balances of a bank. When the condition is good, there is
greater demand for cash. On the other hand, when the business is dull there is
less borrowing from the banks.
8) Existence
of clearing house arrangements: Cash balance of a bank also depends upon the
availability of clearing house facilities. Clearing house settles inter-bank
claims. If there is a clearing house, inter-bank claims can be easily settled
and the banks need not keep large cash balances.