Define cash reserve and give those factors which guide bankers to determine the size of cash reserve or How commercial banks reconcile liquidity of profitability
CASH RESERVE :-
The liquid asset of bank is called cash reserve of bank. It is to be kept by the bank in order to meet the demands of the customers. There are three items which are included in cash reserve.
1. Cash in hand.
2. Cash with the central bank.
3. Cash kept with other banks.
Keep in mind that bank is a profit earning institution. It receives the loan at lower rate of interest and lends it on higher rate of interest. Every bank wants to lend all that money which is deposited with it. But it is not possible. Because it has also to meet the cash requirements of the customers. If it fails to provide the money to the depositors then his reputation will suffer. It will loose the confidence of the people and it will have to go into liquidation. On other hand if they retain major portion of their deposits with them than they will earn merge profit and might go in to losses. So they will have to keep the balance between the liquidity (cash reserve) and profitability.
FACTORS WHICH DETERMINE THE SIZE OF THE CASH RESERVE :-
It is very difficult to frame any rule for the fixation of cash reserves by the bank. However following are the important factors which guide the banker to determine the size of cash reserves.
1. Size Of Deposits :-
If the size of the deposits kept by the customers is large, then a large cash reserve has to be maintained. On the other hand small cash reserve will be required.
2. Nature Of Clients :-
The banks will have to keep large reserves if the clients of the banks are industrialists, brokers and businessmen. Because their demand for cash will be also large.
3. Nature Of Account :-
If people keep major portion of their deposits in the current account if the bank will have to keep large reserves in cash. If major deposits are in savings or fixed account the small reserves will be kept by the bank in cash.
4. Use Of Credit Instruments :-
If cheques and credit cards an used commonly by the public then banks will keep smaller amount of cash reserves as it has been observed in advanced countries.
5. Clearing House Facility :-
If clearing house is not available then every transaction will be made in cash. So large amount of cash reserve is to be maintained. On other hand if this facility is available then small amount of cash reserve is needed.
6. Customers Habits :-
In the under developed countries people accept only cash in buying and selling. So a large amount of cash reserve is needed by the banks.
7. Political Stability :-
If there is political unrest it will lead to economic instability and banks will keep higher cash reserves. On other hand in case of political stability, the banks will keep lesser cash reserves.
8. Urban and Rural Area :-
The bank situated in rural area will keep less cash reserve because farmers demand for money is seasonal on the other hand bank in city, keeps higher reserves.
9. Reserve Ratio Fixed By Govt. :-
Most of less developed countries to safeguard the deposits of people and to use the credit weapons government has fixed the cash reserve ratio at 5% of demand with the Central bank. The banks are also required to maintain 3.5% of the total time and demand liabilities.
10. Nature Of Loan :-
If large portion of funds is used in loans and advances which can not be taken back easily then larger cash reserve will be required by the bank.