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:  Cite

More from this Section

  • FAS #8
    FAS #8 is a regulation of the Financial Accounting Standards Board requiring U.S. companies ...
  • Balloon Payment
    Balloon Payment is a large payment that may be charged at the end of a loan or lease. ...
  • Incremental Analysis
    Incremental Analysis is a choice strategy used to evaluate accounting transactions and ...
  • Capital retention approach
    Capital retention approach is a method used to estimate the amount of life insurance to ...
  • Financial distress
    Financial distress is that financial situation when a firm cann't meet or has ...