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.