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 depression
goods do not move fast through normal channels
 Prices fall
Losses 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 condition
Limitation
• 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 certificate
1.with risk sharing
2.without risk sharing
• RBI may not be a dependable source.
• Raising capital funds is not easy.
Conclusion
• This theory makes a limited
contribution.
Thank
you !!