Page 205 - DCOM304_INDIAN_FINANCIAL_SYSTEM

Indian Financial System

Notes Cash Management system should be effective to increase profitability and liquidity of any
bank. The bank managers should compile periodically information relating to cash receipts,
cash payments and similar other information (weekly) and submit to the head office.

The head office should analyze the data and determine the optima cash levels for huge
withdrawals and determine cash Inventory levels by scientific inventory management techniques.
They can be applied to determine optimal cash levels for each bank and if followed that would
improve the profitability of a bank.

Nature of Secondary Reserve in Commercial Banks

A commercial bank generally relies on highly liquid earning assets to meet its expected and
unexpected financial needs because it can't afford to hold a larger proportion of funds in the
vault for the reasons stated earlier. The aggregate of highly liquid earning assets is designated
as the secondary reserve in banking circles. The principal objective of holding the secondary
reserve is to impart adequate liquidity to funds without adversely affecting the profitability of
a bank. The bank must have such assets which are highly liquid and at the same time generate
some yield on them. Call loans to brokers or bankers which may be terminated at any time at a
very short notice may be regarded as highly liquid assets.

Keeping above requirements of high liquidity, yield and shiftability, the following types of
assets may be grouped in the category of secondary reserve:
1. Call loans to stock brokers and commercial banks.
2. Short term loans to commercial banks.
3. Short term loans secured against self liquidating assets or blue chips.

4. Investment in treasury bills.
5. Promissory notes of short period maturity.
6. Discounting of usance bills eligible for rediscounting from the RBI.
7. Short period debentures of companies.

9.15 Functions of Secondary Reserve in Commercial Banks

The principal function of the secondary reserve is to replenish the primary reserve, while its
subsidiary function is to earn a moderate income. Since it is very difficult of estimate correctly
the working reserve requirements because the bank deals with human beings who are motivated
by a variety of factors, a banker would like to keep a little more cash in the vault than is
absolutely necessary to avoid an illiquid crisis. Secondary reserve helps a banker to trade off
successfully between liquidity and profitability. Where a bank has a surplus in the primary
reserve because of heavy cash inflows, it is invested in secondary reserve assets so that it may be
drawn conveniently. Moreover the bank can earn some yield rather than earning nothing or far
less yield.

Factors Influencing the Level of Secondary Reserve in Commercial Banks

The factors can be classified into External factors and Local factors:

External Factors

1. General state of Economy: If the level of business activity is expected to increase, which
means more demand for business loans the banker can keep large proportion of loans in
secondary reserve to meet the requirements.

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