What are the major Factors that Define Cash Reserve of the Bank? Most of the liabilities of a banker are demand obligations. In order to meet the demand liabilities on deposits, he must keep with him sufficient amount of cash reserve.
This is considered as first line of defence for a bank. If the bank does not keep an adequate amount of cash reserve and at any time banker is not able to meet the demand obligations, then the goodwill of the bank will be affected and faith of customers on the bank will be shaken which may lead the bank to bank-ruptcy.
One the other hand if more cash reserve is kept than the requirements then the profits of the bank will be affected so there is need for an adequate amount of cash reserve to be kept by the commercial bank.
Cash Reserve of a bank is following three forms: Cash with central bank. Cash in hand in form of coins and currency. Balances with other banks.
The part of total capital of any trading bank, financial corporation or institution which is essential to deposit with central bank or to keep with it in cash form is called reserve.
(D.G. Locket)
Ratio of Cash Reserve:
Cash reserve ratio means that particular part of total deposits which is essential to keep with the central bank. Central bank is authorized to bring change in the ratio of cash reserve according to the circumstances. The ratio of cash reserve, which a commercial bank keeps or requires for meeting the demand of its customers, is the discretionary power of the bank.
Factors of Cash Reserve:
The amount of cash reserve cannot be determined by the rule of thumb but it depends upon the following factors:
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Legal Requirements:
If the law requires that every bank must maintain a certain percentage of its deposits as cash reserve as cash reserve with the central bank of the country, then the banks must maintain at least that ratio as reserve. If reserve ratio is raised then more cash reserve is required, and if it is lowered down then less cash reserve may be required.
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Nature of Accounts:
If people deposit their money in current deposits, the bank keeps more money as cash reserve. Whereas; in case of fixed or term deposits bank does not need to keep heavy cash reserve.
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Use of Credit Instruments:
If payments in the locality are mostly made by cheques or drafts or hundies etc., so the amount of cash reserve would be smaller. On the other hand, if transportations are carried mostly on cash basis then a larger reserve will be necessary.
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Development of Investment Habit:
If the people of the place were in the habit of investing their savings in banks, then a smaller cash reserve would be required and vice versa.
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Employment of Funds:
If commercial bank has employed its funds in such a way that at the time of need these can be called back at short notice, then less cash reserve may be needed but if funds cannot be easily converted into cash in need then more cash reserve will be required.
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Rediscounting Facilities:
If there is a central bank in the locality to provide rediscounting facilities to the member banks, then the amount of cash reserve required would be smaller because the commercial banks are rediscount the bills with the central bank to get the funds.
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Nature of Securities:
If the securities are marketable then bank keeps less cash reserve and if the securities are not marketable then the bank keeps more cash reserve.
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