Bank always maintain a security line, let’s discuss the banking lines of defiance for arrangement of asset and diminishing liquidity.
A large percentage of bank’s fund consists of deposits on different terms, payable according to the contractual obligations with the depositors.
It is, therefore, incumbent upon banks to keep uppermost in their mind, while employing their funds, the imperative necessity of meeting their commitments as and when they arise, without the slightest duly, Experienced and successful bankers strike a golden mean by so arranging their various assets (advances, investment etc.) in different proportions of liquidity and profitability that they do not find much difficulty in meeting Various commitments even during period of crisis.
The arrangement of assets in order of rising profitability and diminishing liquidity is known as “Lines of Defiance” which are as under:
Banking Lines of Defiance
The first and foremost line of defense is cash in hand including statutory cash reserve with the Bangladesh Bank and other banks. Cash is the most liquid asset of a bank and risk-free, but cash is also an asset which earns no interest.
Demands of customer are immediately met by the bank from the cash balances. If it fails to honor the customer’s demand, it loses confidence of the public and its very existence will face danger.
In determining the actual amount of cash balance to be kept in the bank vault, the banker has to be very cautious and far-sighted. From the point of view of profitability, he is tempted to minimize his cash holding, whereas, form the point of view of liquidity; he is tempted to maximize it.
Cash is an idle asset and, hence, holding of large balance in cash will affect the profit of the bank. Therefore, an important task of the banker is to determine the size of cash balance to be maintained. The banks and to watch their money position day to day in order to provide their ordinary business needs and to meet statutory requirements.
Banks had to work very largely on estimates and trends in establishing what would be required minimum reserves and money positions they should aim to achieve in order t cove their needs.
Factors and trends influencing determination of cash Balances
Some of the important factors and trends which influence the determination of the amount of cash balances maintained by a banker are as follows:
- Banking Habit: The need to maintain large amount of liquid cash will not be there if the customers are highly banking minded. In advanced counties where people have cheque habit, the use of cash is very much reduced. All transactions are settled through cheques are not freely used and the banks in such countries cannot afford to keep small cash reserve.
- Local Business and Economic Conditions: The habits of there customers, and the business conditions of the area have an important bearing on the cash reserves. Some types of business carried on by the depositors may make heavy occasional demands which the banker will have to meet with adequate provision of liquid cash. Sometimes there will be seasonal demand for withdrawal of cash. During harvesting season or on religious festivals demand for cash increases.
- Banker’s Clearing House: Existence of banker’s clearing house greatly reduces the need of liquid cash to be kept by a bank because he has only to provide for the difference between the cheques drawn on him by other banks and the cheques frown by him on their banks.
- Nature of Accounts: The types of customer’s deposits in current accounts, savings bank accounts and fixed deposit accounts and the average size of deposits also determine the amount of cash balance. If the accounts are of a fluctuation nature, a higher cash reserve may be requiring. If there are a large number of small sized deposits, the danger of large with drowns by any individual customer will be less and, hence, it need not keep a large amount of liquid cash.
- Nature of Advances: The nature of different types of advances made by the banker and the refinancing facilities provided by Bangladesh Bank also affect the cash reserve. The Bangladesh Bank provides advances and re-discounting facilities to banks. A banker may employ more funds in discounting of bills and re-discount the same bills from Bangladesh Bank and, thereby, keep less cash reserve.
- Statutory cash reserve with Bangladesh Bank: Every scheduled bank must maintain with Bangladesh bank an average daily balance not less than four percent of its total demand and time liabilities. This is known as Statutory Cash Reserve. Bangladesh Bank is also empowered to vary the cash reserve as and when considered necessary. Although, the statutory cash reserve, kept with Bangladesh Bank, is considered as liquid asset of a bank but in reality it is not a liquid asset, because it is an statutory obligation and the minimum cash reserve cannot be withdrawn. Failure to maintain a cash reserve would render the bank concerned liable to pay penalties.
2. Money at Call and short Notice
This represents the money lent out to other banks. Call loans-overnight loans or loans repayable on a few days notice-are made to other banks.
Banks borrow from the call money market to meet sudden demand for funds for payment and/or to obtain funds to meet any likely shortfall in their statutory cash reserve ratio with Bangladesh Bank.
This asset has an advantage over cash reserves, in so far as it satisfies, to a certain extent, other liquidity as well as profitability.
It is liquid in the sense that it is recoverable at call or short notice; it is profitable in the sense that it earns interest. This asset constitutes the banker’s second line of defense.
3. Bank’s Investments
The third line of defiance is bank’s own investments. Securities purchased and held for the bank’s own portfolio are shown in this account. These consist of Government Promissory Notes/Treasury Bills, Government Loan and other gilt-edged securities etc., to fulfill the statutory obligation under Banking Regulation Act.
They yield a higher return than that obtained from liquid assist. Every bank has to maintain a specified minimum of its demand and time liabilities (at present 16%) on approved securities over and above their requiems of statutory cash reserve in order to keep the requisite liquidity ratio.
These are less liquid than the money at call lent to other banks, but can be quickly converted into cash, if necessary. Commercial banks undertake investments in approved securities so as to maintain liquidity with a fair degree of profitability.
4. Bills Purchase and Discounted
The fourth line of defiance is bills purchased and discounted from first also parties. Bills discounted may be promissory notes, bills of exchange or treasury bills.
Commercial bank prefers to have assets which mature within a short period and which are easily marketed and also bring some revenue income to the bank.
The retirement of demand bills on presentation and, of since bills on maturity, makes this mode of employment of bank’s fund highly liquid. On the other hand, the bill can be rediscounted with Bangladesh Bank at times of need. Such bills constitute a strong and valuable line of defense.
The fifth line of defiance consists of general advances comprising of loan, overdraft, cash credit and other credits to different types of customers, different industries and professions, small borrowers, trade, agriculture, Government and Semi-Government organizations and Corporations.
Lending is by far the most important function of modern banks. It comprises a very large portion of a bank’s total assets and forms the backbone of the banks’ structure. Major part of banker’s earnings is mainly derived from these assets.
But at the same time, there is lack of liquidity in these assets. A loan may be covered by mortgage of a property, property into liquid cash when needed. A trader or a businessman who borrows money to buy goods cannot be expected to redeem the loan on demand or even at short notice.
Loans and advances may take different forms and are allowed against varied types of securities. Whatever be the form or the security offered, the loans and advances should be only short period or repayable after short period of notice in order to diminishing any possibility of facing liquidity crisis.
Profitability should be given only a secondary consideration. Liquidity and safety should be the prime consideration of a wise and prudent banker.
After social control and nationalization of banks, the whole idea has changed. The advanced, the advances are now need-based and not profit-oriented, the neglected sector has now become preferred and priority sector.
The parties to whom no advance was made by banks formerly do now get preference and priority I the matter of bank’s advances. The policy is now to help the weaker section of the communities who were hitherto neglected and, thereby, make the socialistic goal of the country.
6. Fixed Assets
This item represents the cost of premises, Head office and branches, and other assets, such as, vehicles, computers, furniture and fittings etc. The book value is cost less depreciation and the account is shown in the balance sheet.
Banks must maintain some account some account if fixed assets so that they can conduct their business operations. The acquisition of fixed assets is supported by long term funds represented by paid-up capital and/or a significant amount of retained earnings.
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