Text 4. Bank Investments

The investment policy of a bank is based upon the reconciliation of two conflicting aims. On the one hand the bank wants to make as much profit as it can and for this reason it must take the risks of lending money. On the other hand its funds belong to its depositors and must be available whenever they wish to make withdrawals.

There are two things that the bank must therefore do. First it must keep a proportion of its assets in the form of cash to meet demands. The amount that this needs to be varies very little from one bank to another or from one day to another and experience suggests that it is about six percent. As a cushion against unexpected demands a further proportion of funds is invested at low rates of return in highly liquid lending mostly to firms in the money and capital markets.

The second thing that the bank must do is to ensure that the investments it chooses are safe. This also means that they are relatively low yielding since high yields are associated with risk and with lending for long periods of time. Much of a bank’s investment is in short and medium term government and local government bonds. They yield certain incomes and are readily saleable should the occasion demand.

Advances by a bank to its customers are the least liquid of their assets since there are few borrowers who could repay a loan at very short notice. However, they are also the most profitable of them yielding the highest rates of return. Advances to customers are likely to account for more than two thirds of the banks investment portfolio although this will vary on a day to day basis since overdrafts are the most common form of advance and are not immediately controllable by the bank.