Write short notes on (a) Liquidity Ratio. (b) Fixed Deposits. (c) Money Market.

Answer Details

(a) Liquidity ratio. The liquidity ratio (cash ratio) is the proportion of a commercial bank's total deposits that it keeps in liquid (readily available) form, that is, in cash and near-cash assets, rather than lending out. It is set to ensure the bank can always meet customers' withdrawal demands.

\[ \text{Liquidity ratio} = \frac{\text{Liquid (cash) assets}}{\text{Total deposits}}\times 100 \]

The central bank uses the required liquidity ratio as a tool of monetary policy: raising it reduces the funds banks can lend (tightening credit), while lowering it expands lending.

(b) Fixed deposits. A fixed (time) deposit is money placed with a bank for a fixed, agreed period (for example three or six months) that cannot normally be withdrawn until the period ends. Because the bank can rely on these funds, it pays a higher rate of interest than on current or savings accounts, and the longer the term, the higher the interest. Early withdrawal usually attracts a penalty or loss of interest.

(c) Money market. The money market is the market for short-term funds and financial instruments, that is, loans and securities that mature in a short time (generally under one year). Its instruments include treasury bills, certificates of deposit, commercial bills, and call money. The main participants are commercial banks, the central bank, discount houses, and large firms. It contrasts with the capital market, which deals in long-term funds such as shares and long-term bonds.

Examination takeaway. Keep the time dimension clear: the money market handles short-term finance and fixed deposits are time deposits, while the liquidity ratio is about keeping enough cash to meet withdrawals.