conflicting objectives of commercial banks
Commercial Banks are financial intermediaries which accept savings and grant loans. They are Joint Stock Companies owned by shareholders with the aim of maximizing profits.
A Commercial Bank has two essential groups of person to satisfy, namely:- the shareholders and the depositors (customers). It must make profits for its shareholders and must keep enough liquidity to pay depositors when ever they come to withdraw money from their bank accounts.
Profitability is an objective to satisfy the shareholders of the bank. They have invested their money in the bank because they want to make profits. Commercial Banks have as an important objective of making enough profits for its shareholders.
The objective of profitability can be achieved by granting loans which yield interest and investing in other business to make profits. This explains why some of the assets of Commercial Banks are in the form of advances and investments.
Advances and investments are the most profitable assets of a bank.
Another important objective of a Commercial Bank is that of liquidity. They must keep enough liquid assets to meet up depositors’ demand for cash withdrawals.
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Depositors must be able to have their money whenever they come for it. This is to give them confidence and encourage them to continue savings with the banks.
Commercial Banks use what they have i.e. they use their assets to achieve these two objectives. The problem is that there is a conflict in trying to achieve these objectives. Banks have to keep its assets in the form of advances and investments in order to make profits. But these two assets are very illiquid i.e. it is not easy to convert them into cash. Hence in an attempt to make more profits the bank will be reducing its liquidity.
Liquid assets such as cash in till, money at call and treasury bills are kept for the purpose of achieving the objective of liquidity. But these assets are less profitable.
Cash in till is the most liquid asset but is a sterile asset i.e. it makes no profits. It is cash that lies idle in the coffers of the bank. The most liquid assets are the least profitable. Hence, in an attempt to have more liquidity, the bank will be reducing profitability.
A bank resolves these conflicting objectives by keeping a number of assets which can be used for liquidity and which at the same time are income-earning. Such assets include money at call, treasury bills and short term bills. Some of the assets exist just to provide immediate cash such as cash in till and operational balances. There are also some of the assets which are there only to make profits. These include advances and investments.
In addition, the assets are specially arranged in an increasing order of profitability and a decreasing order of liquidity. From top to the bottom profitability is increasing while liquidity is reducing. Cash in till is the most liquid while advances is the most profitable.
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