BANKING AND INSURANCESERVICES PRESENTATION ON THEORIES OF LIQUIDITY MANAGEMENT SUBMITTED TO :- Mrs. GARIMA SUBMITTED BY :- TANVI SOOD CLASS :- M.COM II ( SEM. 3 ) ROLL NO. :- 4931 It implies conversion of assets into cash during the normal course of business and to have regular uninterrupted flow of cash to meet outside current liabilities as and when due and payable and also ensure availability of money for day to day business operations. .WHAT DO YOU MEAN BY LIQUIDITY MANAGEMENT ??? A measure of the extent to which a person or organization has cash to meet immediate and short-term obligations. or assets that can be quickly converted to do this. LIQUIDITY RATIOS CURRENT RATIO ACID TEST RATIO OR LIQUID RATIO ABSOLUTE LIQUID RATIO . LIQUID LIABILITIES= CURRENT LIABILITIES – BANK OVERDRAFT C) ABSOLUTE LIQUID ASSETS =ABSOLUTE LIQUID ASSETS CURRRENT LIABILITIES ABSOLUTE LIQUIS ASSETS=CASH IN HAND + CASH AT BANK + SHORT TERM INVESTMENTS .A) CURRENT RATIO = CURRENT ASSETS CURRENT LIABILITIES B) LIQUID RATIO = LIQUID ASSETS LIQUID LIABILITIES LIQUID ASSETS= CURRENT ASSETS – STOCK – PREPAID EXPENSES. THEORIES OF LIQUIDITY MANAGEMENT . The success of a bank depends upon the efficiency with which it can provide to it’s creditors (depositors) and mainly on the confidence it inspires among the depositors. Bank has been able to attract the deposits of the people not only by promising some returns of their money but also the amount of liquidity in it’s assets so that it may be able to meet any claims upon it in cash on demand. . The bank must ensure adequate cash on demand. the more obviously it can offer cash in exchange for depositors without any difficulty. The perfect liquid asset is cash itself because it can fully satisfy the claims of depositors. The more cash a bank holds . A bank deals in the money of the people.INTRODUCTION The basic problem of commercial bank is to have a balance between liquidity and profitability. Ultimately . Cash has perfect liquidity but lacks income. At other end. its business will result in losses. . there are some loans and advances which yield high rate of interest. the commercial bank must retain public confidence in order to continue to survive and provide for the liquidity needs for the bank. ways and means of resolving the conflicts have been developed from time to time.Why the need arises ???? If a bank holds a large part of it’s funds in ready cash without earning any income on it . A number of approaches. but hardly liquid at all. In order to ensure long run earnings. the survival of bank is endangered. Bank must employ the resources in advancing loans and investing them in high yielding securities . then bank will lose the confidence of public. These approaches consequently came to be known as “THEORIES OF LIQUIDITY MANAGEMENT”. There is conflict between liquidity and profitability. If banks employ its resources and later on doesn’t have enough cash to meet the demands of customers . THEORIES OF LIQUIDITY MANAGEMENT 1) Commercial Loan Theory 2) Shift ability Theory 3) Anticipated Income Theory 4) Liabilities Management Theory . Logical basis of the theory Commercial bank deposits are near demand liabilities and should have short term self liquidating obligations. Due to Economic Condition the liquidity character of the self liquidating loans are affected. transportation. . The bank holds a Principle that when money is lent against self liquidating papers. They were. A new loan was not granted unless the previous loan was repaid. it is known as Real Bills Doctrine The doctrine had some criticisms. A Commercial Bank must provide short term liquidating loans to meet working capital requirements. storage. distribution and finally consumption. The theory states . Self-liquidating loans refers to the loans which finance movement of goods through successive stages of production.1) Commercial Loan Theory Originated in England during the 18thcentury. Banks should provide loans before the maturity of the previous bills. Another criticism was that It failed to take cognizance of the fact that the bank can ensure liquidity of its assets only when they are readily convertible into cash without any loss Thus the Commercial loan theory was ignored because of the criticisms of the DOCRINE. even the transaction for which loan provided is genuine and whether debtor will be able to repay the debt.During Economic depression Goods do not move fast through normal channels Prices fall Losses to sellers No guarantee . . relying on maturing bills is not needed but maintaining quantity of assets which can be shifted to other bank whenever necessary.G. Soundness of assets .2) Shift ability Theory Originated in USA in 1918 by H. bank should maintain liquidity by possessing assets which can be shifted to the Central Bank. Eligibility of Shifting of assets :. ‘ to attain minimum reserves. Moulton According to this theory. Thus. According to this theory . Moulton specified. as development took place the Commercial Loan theory lost ground in favor of Shift ability Theory . Acceptability are distinct. the problem of liquidity is not a problem but shifting of assets without any material loss. It must fulfill the attributes of immediate transferability to others without loss In case of general liquidity crisis. the whole industry would be in crisis. •During depression.•Blue chip Securities will also lose their shift ability character. the commercial banks were ready to buy them as a collateral security for lending purposes. . both Commercial loan as well as Shift ability theory failed to distinguish liquidity of an individual bank as well as the banking industry. The shares and debentures of well reputed companies would fail to attract buyers and cost of shifting of assets would be high. .Blue chip securities which possess high degree of shift ability. Thus. Prochnow. . That’s what Anticipated Income Theory holds. Loan repayment schedules have to be adopted to the anticipated income or cash receipts of the borrower. Grant loans even if they are not of self-liquidating nature or if the assets are not shift able against which loans are given. Increased participation in term lending. A loan officer must ensure the future earnings or net cash inflows of the borrowing firm for amortization of loans.3) Anticipated Income Theory Developed in 1948 by Herbert V. This is one of the important liquidity management theory. . liquid investments etc. D) Raising of capital funds. Says that there is no need to follow old liquidity norms like maintaining liquid assets . According to this theory . B) Borrowing from other commercial bank. an individual bank may acquire reserves from several different sources by creating additional liabilities against itself. C) Borrowing from central bank. some of which are listed below…… A) Time certificate of deposits.4) Liabilities Management Theory It emerged in the year 1960. These sources include a number of items . B) Borrowing from other commercial banks…… Loans are generally given on one day. Rate of bank loan fluctuates with change in demand and supply in the money market. unsecured basis. Limitation…. These are offered with interest rates. Sensitive to market conditions. Commercial banks compete with each other for it. These certificates bear different maturity date ranging from 90 days to 365 days. . These are negotiable instruments and can be sold by the holder. Limitation….A) Time certificate of deposit……. Every bank mostly faces shortage. Time Certificate of Deposit Specimen 1 . Time Certificate of Deposit Specimen 2 . Funds can be built up by retained earnings and it depends upon the its dividend policy. Limitation…. Available in restrictive terms.C) Borrowing from central bank…… Central bank credit facilities are generally available in the form of discounting or advances for day to day and seasonal liquidity needs of the commercial banks registered with the central bank. D) Raising of capital funds……… Commercial banks can acquire reserves by issue of shares of different features to general public. . Such loans are relatively costlier. ANY QUERIES .