Principles of Commercial Bank

Investment Policy of Commercial Bank: All You Need to Know

There are certain principles of a commercial bank which are set to maintain the market competition in modern days. This article will be discussing the various investment policies and principles of a commercial bank. These forms of banks make their profit from lending. Now, if you are willing to know more about the process of lending and whom the money is given to, you should continue reading this article. Not only this article is going to give an understanding of the principles and investment policy of commercial bank but it will also help people with smart investment ideas. 

What Are The Principles of Lending?

There are certain principles associated with lending which must be adhered to by the bank workers when it comes to lending. Let’s have a look at the principles that must be considered. 

  • Stability - Commercial banks must invest only in securities and shares that can provide sufficient stability. This is one of the important principles that must be followed by the bank to avoid losses on the value of its securities. 

  • Liquidity - Bank grants advance loans on securities that can be easily converted and marketed into cash within a short notice. This is what liquidity means and is an important principle of bank lending. A bank only puts those securities in the investment portfolio which can offer a sufficient amount of liquidity to the bank. This is one of the important principles because the cash helps the customers of the bank in emergencies. Without having to disturb the market prices, the bank should be able to sell securities in short notice.   

  • Profitability - The amount that is being invested must generate sufficient profits and hence profitability is referred to as one of the cardinal principles of lending. The interest rate of the loan decides the earning capacity of shares and securities. It also depends upon the tax benefit and the dividend rate. Hence, the bank must invest in securities that are capable of providing stable return keeping the profitability in mind. 

  • Safety - Another important principle of lending is safety which refers to the important fact that the borrower should be able to repay the loan. Also, the repayment is based on the character of the borrower, his/ her capacity and the nature of the security associated with the loan. Hence, the lender from the bank must maintain the principle of safety and look into the financial stability of the person.

  • Diversity - Any commercial bank must follow the principles of diversity while lending. The bank must be careful that the investment of the surplus funds is diversified and not limited. Also, the bank tries to maximize diversity in order to minimize the risk in regards to the investment portfolio. 

The Investment Policy of The Commercial Bank

Investments in banks are meant for earning profits. They take help of the reserves both primary and secondary to meet the liquidity requirements of the bank. This also helps in meeting the credit needs of society. These needs include short term loans that are provided by the bank. After providing the loan, the bank invests the remaining for a long period to grow and maximize the earning capacity. 

All banks have certain investment policy which goes by the principles of a commercial bank. These investment policies include high returns of unloaded resources.

All of this activity is conducted keeping in mind the principles of lending where often the aim of earning profits clashes with principles of liquidity and safety. Thus, in order to avoid such risk, it is essential to implement the policies which can create a balance between the two principles. Balance in such scenarios refers to maintaining the balance between liquidity and safety and maximizing them in a manner that can produce a generous amount of profit for the bank. 

Why Should A Bank Follow The Principles of Sound Lending?

One of the primary functions of the bank is lending. The deposits that are collected by the bank from its customers are used as loans for the customers who require it. However, a bank cannot function if it provides a loan to the customer without any form of profit-earning objective or for that matter if it does not follow the basic principles of banking. Further, the bank also might face risk if they do not apply the sound lending principles. The interest that the bank received from the customers while repaying the loan, is the most important source of income for the bank. Safety, liquidity, purpose, profitability are some of the principles that must be followed to mitigate risks like loss and fraudulency. 

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FAQs (Frequently Asked Questions)

1. Why is safety the most important principle of bank lending?

Safety is regarded as the most important principles when it comes to bank lending. It is important because the banker should stay assured about the safety of the advance. The safety involves repayment of the loan in time along with the interest. 

2. Mention a few risks involved in the principles of good lending.

The three types of risk involved are liquidity, credit, market and operational. To ensure that none of these risks interferes with the whole functionality, it is the bank’s responsibility to do a background check before committing to lending.