Investments by Banks and Its principles
Investment: The term investment means
employment of funds to buy an asset. Here investment means employment of funds
by the banks to buy securities from the market. The securities which are
purchased by the banker from the market includes:
a) Government
securities: These are the securities which are issued by the governments to
raise funds. These securities are the safest of all securities because these
are guaranteed by the government. Government securities may be of three types:
(i) Stock, (ii) Bearer bonds and (iii)
Promissory notes.
b) Semi-government
securities: These are the securities which are issued by semi-govt.
organisations like Municipal Corporations, Port Trusts, State Financial
Institutions etc and these securities include debentures or bonds.
c) Industrial
securities: There are the securities which are issued by industrial or business
concerns. Bank invests a small percentage of its funds in the shares and
debentures issued by these industrial concerns.
Besides these securities, banks also invest in
fixed deposits, units and capital of various financial institutions. However,
amongst all these, a marked preference of the banker is noted in favour of
government and semi-government securities. Investment by banks in these
securities constitutes the “third line of defence” of the banks.
Principles
of Sound Investment: Banks are one of the genuine investors in the
securities market. Banks invest in the market in the hope of earning some
return. However the investment of funds by banks involves borrowed funds and
hence their prime concern is the safety of the funds invested. A banker
therefore select the securities very carefully and follow the following principles
of sound investments:
1) Safety of
principal: A banker deals in borrowed funds and therefore his main
consideration is safety of principal invested in securities. The banker has to
ensure that the principal invested in securities. The banker has to ensure that
the principal amount invested by him remain safe. The safety of investments
depend on the solvency and ability of the issuing authorities to honour their
commitment made to the investors. The government and semi-government securities
are the safest securities because they are guaranteed by the government.
2) Price
stability: The price of security selected by the banker should remain stable.
The safety of investments depends on the stability in the prices of securities.
Banker is not a speculator and hence his object of buying security should not
be to gain by a possible rise in the price of securities which are liable to
wide fluctuations in their prices and should prefer those securities whose
prices remain fairly stable over a period of time. The Prices of government
securities remain stable and do not fluctuate.
3) Marketability
or liquidity: The primary objective of buying securities by the banker is to
earn income and at the same time maintain his liquidity position. Thus, the banker
should see that the security in which he invests his funds possesses a ready
market i.e. they can be sold in the market without loss of time and money.
Marketability of securities ensure liquidity of investments Government and
semi-government securities are highly liquid as they have a ready market.
4) Profitability
of yield: After ensuring the safety of the principal money invested in
securities, the banker should consider the returns from the investments. In
other words, the banker should not give undue importance to higher yields at
the cost of safety. The banker should not expect windfall profit, because high
profit may bear the germ of loss.
5) Diversification
of Investment: The banker should diversify the risk involved in investment by
investing in wide variety of securities issued by wide variety of business
enterprises belonging to different trade and industry.
6) Refinance:
To ensure the liquidity of his investments the banker has to see that the
security is eligible to obtain refinance from the Central Bank and other
refinancing institutions.
7) Duration: In
addition to the above factor, a banker also considers the duration and
denomination of security and its future earnings prospects.
In
conclusion, it may be said that for a banker the government and semi-government
securities are most ideal for investment of funds. Government securities with
virtually no risks, have a ready market, are eligible for refinance and bring
reasonably good return.