How do commercial banks strike a equilibrium between their liquidity and profitability?
ANS. TRADE OFF Involving LIQUIDITY AND PROFITABILITY
A commercial financial institution discounts in the business of banking with a look at to make gains.
In order to receive gains, the asset portfolio of a financial institution is of utmost significance.
It also presents a photo of the soundness of a commercial financial institution.
The fashion in which a financial institution applies the a variety of resources of funds on various styles of assets reflects the soundness of the financial institution .
Each financial institution has two crucial targets :
Considering the fact that these two targets are contradictory in nature, a excellent banker aims to reconcile each these targets by making diversified and balanced asset portfolio.
The two most crucial targets of a commercial financial institution are :
- PROFITABILITY :
Each financial institution aims to receive optimum gain for its shareholders
Consequently, it invests in all those assets that give them greatest returns
Such assets are of extensive – phrase in nature and so,
They cannot be very easily transformed into hard cash .
So, these assets are fewer liquid in nature and so cannot be utilized to meet the withdrawal demands of the buyers (depositors)
Such assets include things like :
- Money credit and overdraft
- Phrase loans
- Financial commitment in shares, shares, bonds, debentures, mutual funds
- Loans and developments (extensive phrase)
- LIQUIDITY :
Liquidity is the second most crucial goal of a commercial financial institution as it makes certain the bank’s own security and protection.
Consequently a financial institution should really make investments in all those assets that can be very easily transformed into hard cash.
It readily meets the withdrawal requires of the depositors and assists to construct their self-confidence and belief in the financial institution.
Nonetheless, the more liquid the asset is, the fewer gain it yields.
These assets include things like :
- Money balances
- Funds at contact and limited notice
- Payments of exchange.
- Financial commitment in Governing administration securities.
- Hence these twin-conflicting targets of liquidity and profitability can be accomplished to their optimum amount by correctly allocating the funds to a variety of assets.
- These assets are proven in the equilibrium sheet in ascending order of profitability and descending order of liquidity.
- A perfectly – diversified and equilibrium asset portfolio assists in making a ‘trade –off’ or a reconciliation between liquidity and profitability.
- Conclusion :
There fore, a commercial financial institution has to strike a equilibrium between the contradictory targets a liquidity and profitability.
This can be accomplished with an optimum combine of assets that lead to a audio and successful banking process.