Money and Trade

Show how the banks attempt to reconcile the conflict between liquidity and profitability.

Banks have to contend with conflict that exists in their business. On one side banks must have a commitement to satisfy their customers’ cash requirements. This is known as the liquidity requirement since cash means liquidity. On the other side is the demand by the shareholders for dividends which exerts pressure on the banks to be profitable. This is the fundamental conflict between liquidity and profitability.

The diagram above illustrates the strategy banks will adopt in their efforts to reconcile the above conflict between liquidity and profitability. A small proportion of the bank’s assets will be held in liquid form in the form of Cash and Money at Call. As can be seen from the diagram the largest segment is of profit making assets with approximately 50% of their assets in the form of loans and overdrafts. The most successful portfolio of assets would be one that would enable the bank to earn maximum profits while ,maintaining the rquired degree of liquidity.