Conceptual Review of the Role of Commercial Banking to the Economy

Commercial Bank balance sheet structure

This represents a statement of the financial position of the bank on a given date. It contains information relating to the Bank asset holding, liabilities and owner supplied capital, asset represents the resources used by the bank.

The liabilities and owner’s equity indicate how those resources are financed.

Example of a balance sheet of one of the leading commercial bank in Nigeria



Cash & Short term funds 44,633,790.00 22,639,039.00
Short – term investments 13,721,471.00 17,038,334.00
Loans and advances 45,957,835.00 38,945,949.00
Advances under finance lease 2,222,007.00 1,590,466.00
Other asset 4,760,856.00 5,555,186.00
Long-Term Investments 19,173,155.00 4,137,000.00
Investment Properties 5,602,394.00 6,877,448.00
Investment in subsidiaries 1,550,405.00 1,550,405.00
Deferred tax assets 376,326.00 40,831.00
Fixed assets 4,864,309.00 7,217,445
Equipment on lease 30,053.00 42,025
Goodwill 3,081,993.00 4,030,299
TOTAL ASSETS 45,974,674.00 109,664,427
Deposit & other accounts 106,933,727.00 25,026.350
Other liabilities 11,634,139.00 7,634,014
Taxation payable 606,413.00 684,735
Deferred tax liability    
Total liabilities 119,174,279.00 83,345,099
NET ASSETS 26,800,395.00 26,319,328
Share capital 5,276,423.00 5,276,423.00
Share premium 13,319,141.00 13,319,141.00
Share reserved 5,276,423.00 5,276,423.00
Other reserved 2,928,408.00 2,447,341.00
SHAREHOLDER’S FUND 26,800,395.00 26,319,328.00


The Concept of Liquidity and Profitability

We noted that the overriding objectives of commercial banking are to make profit. Profit is made as loans are granted at higher interest rates than those paid on deposits. Hence the greater the volume of loans made by commercial banks the larger the volume of profit. However, loans generally take time to be paid back hence they are not as liquid as other financial assets categorized earlier as reserved assets.

In general the more liquid the asset, the lower the rate of interest paid on it (idle cash, the most liquid asset, for example, commands a zero interest) Hence there is a trade-off between profitability and liquidity. Increasing profitability can only be achieved at the expense of some loss liquidity.

Commercial Bank must maintain some level of liquidity in order to fulfill their liabilities to their customers any time they come to with draw some or all their demand deposits. It follows that such institutions must carefully balance their need for adequate levels of reserve assets against their desire to earn profits by maximizing advances to consumer. If commercial bank grants too many loans (advances) it may end up in a liquidity squeeze, similarly a bank that maintains huge reserve assets may find its yearly profit lower than needed to continue in the industry.

Borrowing and Lending

Lending has become vital function in banking operations because of its direct effect on economic growth and business development. This is being pursued in most countries particularly the developing ones where banks and their lending activities have been usefully integrated into government policy formulation in the national economic development process. As for as banks are concerned their role as lenders is as important as that of deposit taking considering the interrelationships between one and the other.

Principle of Good Lending

When a request for a loan is received, it is important to ascertain the credit worthiness of the borrower, and if it is limited liability Company, it is necessary to pursue it memorandum and Articles association to if there are precluding clauses for limitations on borrowing.

Before a loan is granted the following has to be considered:

Personal Characteristics: Three important elements deserve these evaluations in order to access the personal characteristics of a customer who presents a loan request.

  • Character: Who are the customer, what is his previous relationship with the bank and what does his previous credit record look like? A banker has to know the customer based on the existing banker – Customer relationships.
  • Capacity: Previous track record will determine if the bank has the capacity, morale, and technical and management ability to execute the project for which a loan is being sought. Unless the borrower’s capacity is apparent, loans may become irrecoverable.
  • Capital: Capital refers to the borrower’s wealth position measured by financial soundness and market standing. Can the firm or individual withstand any deterioration in its financial position?

Purpose of the Loan: First the purpose must be one which is satisfactory from the banker’s perspective and secondly it should be within the regulatory lending framework provided by the central bank. Before a loan is granted the banker will make sure that the purpose of the loan is for a good project.

Amount of the Advance: It is important to assess whether the amount being sought will be adequate to satisfactorily carry out the venture, customers after underestimate their requirements and then find half way through the project, that additionally finance is required. Banks nowadays require detailed cash flow projections to assist in appraising customer needs to before a lending decision is made.

Duration of the advance: Before a loan is granted the banker must consider the duration of the loan, with deposit liabilities mainly repayable on demand, commercial banks have taken the view that their finance should be short term and possibly limited to the provision of working capital which is their traditional role.

Source of Repayment: No bank wants a loan to crystallize into hardcode borrowing. Consequently the main test of the customers loan request is the ability to repay from sources which must be reasonable certain and adequate.

Remuneration on the Advance: A bank is not a charitable organization; most of the funds available for lending attract specified rates of interest, which have become highly competitive on the Nigerian seen. Therefore banks should grant loans to customers who can generate ancillary sources of income.

Security for the Advance: Bank normally require security, more as and insurance against unknown events, which may render the proposed loan repayment plan difficult or impracticable. The value of banks security must be constantly watched in order to protect the bank in case of realization, which is often length costly and complicated. The branch manager is best equipped for this role.

The Role of Banking in the Economy

Banks are financial intermediation; channeling surplus money from a lender to a borrower at a rate of return is called the interest rate. The lender of funds usually called Surplus Saving Unit (SSU’S) can be individuals, business firms or even the government (all such as have excess money and are ready to part with them temporarily at a rate of interest). The borrowers of money (called the Deficit Units, DU’S) can also be individuals, (households) business organization or the government.

The essential characteristic is that such need more money than they presently have to fulfill one need or the other, and are ready to obtain the needed money at a rate of interest. The Banking Financial Institutions (BFI) is institutions which serve as links between the surplus and the deficit units.

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