Investment policy of Commercial Banks

03/05/2020 2 By indiafreenotes

A bank makes investments for the purpose of earning profits. First it keeps primary and secondary reserves to meet its liquidity requirements.

This is essential to satisfy the credit needs of the society by granting short-term loans to its customers. Whatever is left with the bank after making advances is invested for long period to improve its earning capacity.

Before discussing the investment policy of a commercial bank, it is instructive to distinguish between a loan and an investment because the usual practice is to regard the two as synonymous. The bank gives a loan to a customer for a short period on condition of repayment.

It is the customer who asks for the loan. By advancing a loan, the bank creates credit which is a temporary source of fund for the bank. An investment by the bank, on the other hand, is the outlay of its funds for a long period without creating any credit. A bank makes investments in government securities and in the stocks of large reputed industrial concerns, while in the case of a loan the bank advances money against recognised securities and bills. However, the goal of both is to increase its earnings.

The investment policy of a bank consists of earning high returns on its unloaned resources. But it has to keep in view the safety and liquidity of its resources so as to meet the potential demand of its customers.

Since the objective of profitability conflicts with those of safety and liquidity, the wise investment policy is to strike a judicious balance among them. Therefore, a bank should lay down its investment policy in such a manner so as to ensure the safety and liquidity of its funds and at the same time maximise its profits. This requires adherence to certain principles.

Principles of Commercial Banking

Principles of Liquidity

A commercial bank offers two types of deposits

  • Demand depositswhich the bank has to repay on demand like a Savings Account and
  • Time deposits which the bankhas to repay after the expiry of a certain period

Further, on a daily basis, customers withdraw as well as deposit cash. therefore, all commercial banks have to keep a certain amount of cash in their custody to meet the cash demands of customers.

Principles of Profitability

Any commercial enterprise primarily tries to generate profit. A commercial bank is a commercial enterprise as well. Hence, it tries to generate profits.

Principles of Solvency

Commercial banks must be financially sound. Further, they need to maintain a certain required capital for running the business.

Principles of Safety

A commercial bank accepts deposits from its customers and then invests it. However, since it is investing the investor’s money it keeps the safety of the money first.

Principles of Collection of Savings

This is one of the most important principles in the current banking scenario. Commercial banks seek huge amounts of idle money from their clients. In fact, bank employees are given targets to collect more savings from people.

Principles of Loans and Investment Policy

A commercial bank primarily earns money through its lending and investing activities. It also ensures that the investor’s money is invested in viable projects. Therefore, banks need strong loans and investment policies to earn a good profit.

Principles of Economy

Commercial banks always try to avoid any unnecessary expenditure. Therefore, they try to manage their functions within a set budget and increase their profits.

Principles of providing services

Commercial banks are usually service-focused banks. After all, good service ensures a better reputation and therefore, profits.

Principles of Secrecy

Commercial banks ensure that they keep the accounts of their clients secret. Also, access to the accounts is given only to legitimized persons.

Principles of Modernization

We live in an era of technology as well as modernization. Therefore, to cope with the advancements in the world, commercial banks adopt modern technical services like online banking, mobile banking, etc.

Principles of Specialization

Apart from modernization, we also live in the age of specialization as well as super-specialization. Therefore, commercial banks segment their entire functions into smaller units and place their employees according to their efficiencies.

Principles of Location

Usually, commercial banks choose a location where they think they can find many customers.

Principles of Relation

All commercial banks try to maintain good relations with their existing clients as well as potential customers.

Principles of Publicity

Any successful business needs good publicity. Therefore, most successful businesses advertise to get the attention of more customers. Hence, commercial banks follow the principles of publicity.