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Definition

Self-liquidating theory

Liquidity theories are of three different types. They are self-liquidating theory, shiftability theory, and anticipated income theory. The self-liquidating theory is also known as the real bills doctrine.

Real bills doctrine is a conservative and traditional banking theory. The main theme of this theory is that the earning asset of a bank should be limited to short-term self-liquidating productive loans that include self-liquidating commercial paper or short-term loan intended to provide the current working capital, which in itself is of a self-liquidating nature. The advantage of the ‘self-liquidating theory’ of commercial bank assets is mainly derived from the fact that such loans are considered to liquidate themselves automatically out of the sale of goods covered by such a transaction.

Some of the arguments used for emphasizing this theory were so absurd and childish that those were quickly withdrawn. The validity of this theory has been challenged by some modern writers. They argued that the transaction backed by a self-liquidating paper does not by itself always guarantee the loan’s liquidity, specifically when there is an abnormal decline in the prices of these commodities covered by the transaction.

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