Introduction to Finance

Asset Management 
A bank needs cash assets to meet depositor withdrawal requests 
when demanded. However, cash assets do not earn interest for the bank. Thus, the more cash 
assets are held, the lower the profi tability, and vice versa. In contrast, banks earn higher 
interest on loans and on longer-maturity securities investments. However, these types of assets 
bank liquidity 
refl ects ability to 
meet depositor withdrawals and to 
pay off other liabilities when due
bank solvency 
refl ects ability to 
keep the value of a bank’s assets 
greater than its liabilities
liquidity risk 
likelihood that 
a bank will be unable to meet 
depositor withdrawal demands and 
other liabilities when due
3
In the case of credit unions, the members buy shares.

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C H A PT E R 3 Banks and Other Financial Institutions
are not easily converted into cash assets, and if converted the conversion costs can be quite 
high. For example, if a loan is sold to another investor, the loan may have to be heavily dis-
counted; that is, sold well below its face value.
Let’s now return to the aggregate bank balance sheet depicted in Figure 3.5. The cash assets 
of the fi rm included under the heading “cash and balances due from depository institutions” 
are considered to be the bank’s 
primary reserves 
to meet liquidity requirements. Vault cash 
and deposits held at other depository institutions and at Federal Reserve Banks are immediately 
available. Cash items in process of collection, while not immediate cash, are being converted 
into cash on an ongoing basis. However, primary reserves do not earn interest, and thus, bank 
managers want to minimize the amount of primary reserves they hold. Notice that FDIC-insured 
commercial banks hold primary reserves that amount to about 7 percent of total bank assets.
To supplement their primary reserves, banks also hold secondary reserves to help meet depos-
itor withdrawal demands and other liabilities as they come due.