7 Essentials of a Sound Banking System: Read In Detail

Liquidity

A sound banking system necessitates a greater degree of liquidity. The bank holds a relatively small quantity of its assets in cash. As a result, the bank’s other assets must fulfill the liquidity requirement so that they can be converted into such fast.

A commercial bank is required to pay its depositors their money on demand. This is only feasible if the bank has readily sellable securities. To assure liquidity, central banks have forced businesses to maintain a certain amount of their funds in cash.

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Safety

A sound banking system must also be safe. Because the bank holds its clients’ money, it is responsible for ensuring that it is secure. As a result, if debtors to banks do not pay back their loans on time and lose money on their investments, the bank will go bankrupt.

Its depositors’ assets would be lost, and they would suffer as a result of this. As a result, the bank is obligated to safeguard its deposits.

Stability

A good financial system must be stable. It should operate logically. There should be no credit contraction or growth. If the bank restricts credit creation when business needs it most, it will harm the company community’s interests.

On the other hand, if it expands credit when economic conditions do not allow, it will result in a boom and inflation. The banking system should follow a consistent lending procedure to achieve stability. By adopting a flexible credit control strategy, the nation’s central bank can assist commercial banks in achieving financial stability.

Elasticity

It’s important to note that despite its name, the RDI isn’t a real-time process. It takes time for assets to move through the distribution chain and arrive at their final destination; lag times can be quite long in some cases. However, because of this lengthy procedure, certain types of financial instruments have become less liquid than they used to be.

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Profitability

A sound banking system must be able to generate a sufficient profit. It has to pay corporate tax, attract interest from investors, and give dividends to shareholders as any other firm would. So, unless the bank is profitable, it won’t function properly. It must take prudent lending and investment policies in order for it to function effectively.

Reserve Management

The ideal liquidity management system for your organization should incorporate the concept of efficient reserve management. In the case of an emergency, a bank keeps some money on hand to serve its customers’ needs. Although the money in reserve is inactive, a bank cannot afford to keep a little amount on hand at all times.

In addition, the central bank has imposed some statutory limits on reserve requirements with itself and with the bank. However, a bank’s reserve policy is governed by its own judgment, expertise, and size of the institution. The bank should handle its reserve policy well and effectively without keeping too much or too little money. It must strike a balance between profits and safety.

Expansion

A sound banking system must be established across the country. It should not only focus on big cities and towns but also on rural areas and underdeveloped regions.

The deposits may only be mobilized and credit options given to trade, industry, agriculture, etc. by broadening the banking system throughout the nation.

This is especially true in a developing nation where the banking system must extend its operations to all sectors in order for it to provide these services. This is essential for promoting capital accumulation and economic development.