Definition Of

Liquidity Theory

Liquidity means the capacity to produce cash on demand at a reasonable cost. A bank is considered to be liquid if it has ready access to immediately spendable funds to reasonable cost at precisely the time those funds are needed. No doubt, the most liquid asset is cash in the vaults of a bank. It is necessary for a banker to keep a certain percentage of the deposits in the form of liquid cash as reserve, either in his own vaults with central bank. But such liquid cash does not earn anything and remains idle. So the banker should invest his excess money in some assets which are liquid in a nature and any consider liquidity ahead of profitability if there is any question of choice.

There are three different liquidity theories:

  1. Self-liquidating or real bills doctrine
  2. Shift ability theory
  3. Anticipated income theory
Share it:

More from this Section

  • Basel Accord
    Basel Accord is an agreement that required that banks hold as capital at least 8% of their risk-weight assets.
  • Business Risk
    Business Risk is the risk associated with projections of a firm’s future returns on assets or returns on equity if the firm uses no debt.
  • Certificate of deposit
    Certificate of deposit is an interest-bearing receipt for the deposit of funds in a bank or nonbank thrift institution for a specified period of time.
  • Bank run
    Bank run is a financial panicking, in which all depositors attempt to withdraw all of their funds simultaneously.
  • Bid or Tender Bond
    Bid or Tender Bond is a bond which provides an assurance of the intention of the party submitting a tender (i.e. the principal) to sign a contract if his tender is accepted
  • Events of defaults
    Events of defaults is a section contained in most loan agreements listing what actions or omissions by a borrower would represent a
  • Participation loans
    Participation loans is the purchases of loans by a third party, not part of the original loan contracts.