Liquidity in Case of Loans
Posted by Ripon Abu Hasnat on Tuesday, February 26, 2019 | 0 comments
Lending is the most profitable business of a commercial bank, but it is highly risky too. Leading is always accompanied by the credit risk arising out of the borrowers’ default in repaying the money. A banker should, therefore, manage his loan business in a safe and profitable manner.
Liquidity means ease of conversion of an asset into cash. As a major part of commercial bank liabilities is payable either on demand or on short notice, the banker should ensure that the loans are liquid. Liquidity, thus, signifies the readiness with which the bank can convert its assets into cash with no or insignificant (small) loss.
1. A loan will be liquid if it has been given for a short period to finance some purchases of stock, raw materials, etc.
2. A banker should give short-term advances which can be recalled in time to satisfy the demands of the depositors.
3. Bank should not lend short period funds for a long time. As in that case, the loans and advances will tend to be less liquid, and it would be a great problem for it to realise cash in case of an emergency.
4. Loans, to be liquid, should be given against the security of quickly realizable assets so that in case the borrower defaults in repayment; these might be readily converted into cash.
5. Cost of borrowing from the Bangladesh Bank:
(i) It is related to the net liquidity ratio.
(ii) Net liquidity ratio is the ratio of the net liquid assets of the borrowing bank to its aggregate demand and time liabilities.
(iii) The net liquidity ratio of a bank must be equal to the specified limit or above it, so that it may obtain a loan from the Reserve Bank at the bank rate.
(iv) With every one percent drop in the net liquidity ratio of the borrowing bank, the cost of lending by the Reserve Bank goes up by one percent.
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