Bank investment

Broadly speaking, investing means committing capital with the expectation of making a profit. The first step in any investment program is for the investor to analyze specific situation. The analysis will contain specifics in terms of income desired, cash requirements, level of risk, and so forth. A second step is to select general investment options that best fit the specific needs of the investor. For example, investors should decide how much, if any, of their assets (economic resources) should be committed to real estate, bonds or stocks. The third step is to select specific investments within the general areas. Generally, there are five criteria to use when selecting an investment option:

1. Investment risk – the chance that an investment and all its accumulated yields will be worth less at some future time than when the investment is made.

2. Yield – the increase in the value of an investment over time, usually a year.

3. Duration – the length of time assets are committed.

4. Liquidity – how quickly one can get back invested funds when desired.

5. Tax consequences – how the investment will affect the investor`s tax situation.

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 i.e. take their money back from a bank`s assets.

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 caution against unexpected demands a further proportion of funds is invested at low rates of return in any liquid lending mostly to firms in the money and capital markets.

The second thing that the banks 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 risks and with lending for long periods of time. Much of 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 rate 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.

In general, banks do not lend to industry for long periods of time or for investment projects. They regard themselves as providing working capital rather then the fixed capital.