Liquidity Management

The Commercial Loan Theory• Originated in England during the 18th century

•The theory states ;

A Commercial Bank must provide short term liquidating loans to meet working capital requirements.

The bank should refrain from long term loans

•Logical basis of the theory

Commercial bank deposits are near demand liabilities and should have short term self liquidating obligations.

The bank holds a Principle that when money is lent against self liquidating papers, it is known as Real Bills Doctrine.

The doctrine had some criticisms. They were;

A new loan was not granted unless the previous loan was repaid.

Banks should provide loans before the maturity of the previous bills

Due to Economic Condition the liquidity character of the self liquidating loans are affected.

• During Economic depressiongoods do not move fast through normal channels Prices fallLosses to sellers

• No guarantee , even the transaction for which loan provided is genuine and whether debtor will be able to repay the debt.

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.

Shiftability Theory

• Originated in USA in 1918 by H.G.Moulton

• According to this theory, the problem of liquidity is not a problem but shifting of assets without any material loss.

• Moulton specified, ‘ to attain minimum reserves, relying on maturing bills is not needed but maintaining quantity of assets which can be shifted to other banks whenever necessary

• According to this theory ;

It must fulfill the attributes of immediate transferability to others without loss

• In case of general liquidity crisis, bank should maintain liquidity by possessing assets which can be shifted to the Central Bank.

Eligibility of Shifting of assets Soundness of assets Acceptability are distinct

Thus, as development took place the Commercial Loan theory lost ground in favor of Shiftability Theory

• Blue chip securities which possess high degree of shiftability, the commercial banks were ready to buy them as a collateral security for lending purposes.

• During depression, the whole industry would be in crisis. 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 will also lose their shiftability character.

Thus, both Commercial loan as well as Shiftability theory failed to distingish liquidity if an individual bank as well as the banking industry.

Anticipated Income Theory

• Developed in 1948 by Herbert V.Prochnov

• Most striking Developments of commercial banks that took place was in participation of term lending.

• The banker plans the liquidation of the term loans from anticipated earnings of the borrower.

• Loan repayment schedules have to be adapted to anticipated income

• Estimation of future earnings should be made.

The liability Management Theory

Introduction

• It emerged in the year 1960.• This is one of the important liquidity

management theory.• Says that there is no need to follow old

liquidity norms like maintaining liquid assets , liquid investments etc.

Proposes many alternatives

Certificate of deposits• Is a negotiable instrument.• Maturity date.Limitations• Interest rates.• Commercial banks compete with each other

for it.

Borrowing from other banks• Short term• Sensitive to market conditionLimitation• Every bank mostly faces shortage

Borrowing from the central bank• Available in the form of discounting and day

to day and seasonal liquidity needs.Limitations• Costlier• Restrictions

Raising of capital funds• By issue of shares• Depends on public response , dividend and

growth rate. using Reserve profit

Potentiality of liability management theory in India

• Inter bank participation certificate1.with risk sharing2.without risk sharing

• RBI may not be a dependable source.• Raising capital funds is not easy.

Conclusion• This theory makes a limited contribution.

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