Essentials of a sound banking system- Nelson Fernandes
- 1. Essentials of a Sound Banking System
- 2. Some of the essentials of a sound banking system are as follows: As pointed out by Crowther, “The secret of successful banking is to distribute resources between the various forms of assets in such a way as to get a sound balance between liquidity and profitability, so that their is cash (on hand or quickly realizable) to meet every claim, and at the same time enough income for the bank to pay it way and earn profits for its shareholders.” But modern bankers also consider a few other essentials which are discussed below.
- 3. 1. Liquidity: One of the essentials of a sound banking system is to have a higher degree of liquidity. The bank holds a small proportion of its assets in cash. Therefore, its other assets must possess the criterion of liquidity so that they may be turned into such easily. A commercial bank is under an obligation to pay its depositors cash on demand. This is only possible if the bank possesses such securities which can be easily liquidated. Central banks have made it obligatory on the commercial banks to keep a certain proportion of their assets in cash to ensure liquidity.
- 4. 2. Safety: Another essential of a sound banking system is that it must be safe. Since the bank keeps the deposits of the people, it must ensure the safety of their money. So it should make safe loans and investments and avoid unnecessary risks. If the debtors of the banks do not repay the loans in time and it loses on its investments, the bank shall become insolvent. As a result, its depositors lose money and suffer hardships. Thus the bank must ensure the safety of its deposits.
- 5. 3. Stability: A sound banking system must be stable. It should operate rationally. There should neither be undue contraction nor expansion of credit. If the bank restricts the creation of credit when trade and industry need it the most, it will harm the interests of the business community. On the other hand, if it expands credit when the economic conditions do not permit, it will lead to boom and inflation. So the banking system should follow a stable lending policy. The central bank of the country can help in achieving stability in the banking operations of the commercial banks by a judicious credit control policy.
- 6. 4. Elasticity: But the stability of banking operations should not be interpreted as rigidity. Rather, the banking system should have sufficient elasticity in its lending operations. It should be in a position to expand and contract the supply of loanable funds with ease in accordance with the directives of the central bank of the country.
- 7. 5. Profitability: A sound banking system should be able to earn sufficient profits. Profits are essential for it to be viable. It has to pay the corporation tax like any other company, pay interest to its depositors, dividend to shareholders, salaries to the staff and meet other expenses. So unless the bank earns, it cannot operate soundly. For this purpose, it must adopted judicious loan and investment policies.
- 8. 6. Reserve Management: Sound banking system must follow the principle of efficient reserve management. A bank keeps some amount of money in reserve for meeting the demand of its customers in case of emergency. Though the money kept in reserve is idle money, yet the bank cannot afford the risk of keeping a small amount in reserve. There are, however, some statutory limits laid down by the central bank in maintaining minimum reserves with itself and with the bank. But how much reserve money should a bank maintain is governed by its own wisdom, experience and the size of the bank. The bank should manage its reserve policy effectively and efficiently without keeping too much or too little cash. It has to balance between profitability and safety.
- 9. 7. Expansion: A sound banking system must be spread throughout the country. It should not be concentrated only in big towns and cities but in rural areas and backward regions. It is only by widespread expansion of the banking system that the deposits can be mobilised and credit facilities can be made available to trade, industry, agriculture, etc. This is especially the case in a developing country where the banking system must provide these facilities through its expansion in all areas. This is essential for capital formation and economic growth.
- 10. Thank You