Variable Cash Ratio VS Liquidity Ratio Cash

Variable Cash Ratio VS Liquidity Ratio

A policy of variables cash ratio is the statutory variation of cash reserve that commercial banks must maintain with the central bank of their country in order to maintain the cash flow in the economy. The working of the technique rests on the assumption of a direct link between advances made by these institutions and cash. Herein, in fact lies the weakness of the technique. Cash is just one of the many variables that is used in determining the availability of credit.

The existence of short term assets that can easily be shifted to the central bank of the country, and the ease of access to funds from abroad (by banks that are mere branches of international corporations), may render the policy ineffective of variable and cash ratio and liquidity ratio. Thus, the ideal environment for the use of the technique is;

1. Where government securities are not large in magnitude or, if they are, the commercial banks are prevented from shifting them to central bank and
2. Where the government takes steps (like requiring incorporation within the country, as in the case of Nigeria, as a condition for doing banking business) that prevent access to foreign funds. It is this weakness of the policy that led those in charge of the central bank to develop the variable liquidity ratio technique.

Variable Liquidity Ratio

This technique incorporates the farmers of the cash ratio and the supplementary reserve requirement. It requires the central bank to prescribe, whenever it so desires, the percentage of specified liquid assets (cash inclusive) the commercial banks must hold against their deposits. The major features of this technique are that it combines the advantages of the variable cash ratio and the supplementary reserve requirement, and when applied thoroughly, it affects the liquidity position of the commercial banks directly.

The major shortcoming of the policy is that it is too uniform in its effects. It also does not discriminate among commercial banks in terms of either their liquidity position or their location, their size or even their ownership structure as the case may be. In the United States Of America, which is generally regarded as the cradle of this techniques, the prescribed ratios have often been made to vary with the size and location of the location of the banks, their liquidity position, and even ownership as between residents and non residents.

In Nigeria today, it takes at least these factors into account in the prescription of these ratios as stated on this article. What can one say in conclusion about the direct control of bank liquidity? One thing is sure about the technique, it appears to be a more effective weapon for controlling the availability of bank credit, than the traditional wealth by the growth of government securities and their shift-ability to the central bank.

In addition to the above information, the effect of liquidity control is more direct on the commercial banks capacity and willingness of these commercial banks to lend, and does not work in as round-ability process, implicit in the looking in effect which is associated with the interest rate cum open market weapon.

But a major defect o the policy is that its effects are limited to the commercial banking system. To the extent that commercial banks are not the only purveyors of credit, the policy may not be effective. Another shortcoming is that, like the traditional weapons direct control of bank liquidity is too general in its effects. it is this shortcoming is that makes the use of selective control a more potent weapon of monetary control not only in advanced countries but also, more importantly, in developing economies.