Liquidity means the ability of the bank to give cash on demand. Generally, the business of the bank depends upon the confidence of depositors on the bank and the depositors feel confident when they are sure that they can demand their money back at any time.
Therefore, every bank must keep the adequate amount of liquid assets. The term liquid asset means those assets which can be readily converted into cash without any loss.
Factors determining the cash balances: The following factors help the banks to decide the quantum of cash balances to be maintained:
(i) Banking habit: Banking habits play a significant role in determining the cash balances of a bank. Banking habits refers to the utilisation of banking services by the public. If the people have e-banking habits then the use of cash in transaction is reduced and the banks need to keep lesser amount of liquid cash.
(ii) Structure of banking: The banking structure of the country also influence the liquidity requirements of the bank. In a branch banking system, the banks can function with less cash reserves because in case of emergency cash can be transferred from one branch to another. Whereas in unit banking system higher cash reserve is required.
(iii) Nature of bank accounts: The nature of deposit accounts viz. savings, current or fixed accounts affect the amount of cash balance to be kept by the banks. In case of fixed deposit account holders, the bank can manage with less cash balance as against current account where it must keep larger cash balance.
(iv) Type of depositors: The type of depositors is another determinant of cash balance of the banks. If the majority of the depositors of the bank are business firms, corporations, schools, college etc. the bank will have to maintain high liquidity because of unpredictable. On the other hand, if the deposits are mostly by individual customers and are of personal nature, the bank can operate with less liquid cash.
(v) Nature of advances: The nature of advances of bank i.e. loans, cash credit, overdraft and purchasing and discounting of bills also affect the size of the cash balances of the bank.
