liquidity and profitability

Commercial banks are profit seeking organizations. The way the commercial banks handle their portfolio is how the profits are reflected in their books. Portfolio management is basically how the commercial banks handle their assets and liabilities. Portfolio management refers to the management of assets and liabilities in such a way that the profits are maximized. Though banks want to make profits but at the same time they are concerned about liquidity and safety. In fact these three namely liquidity, profitability and safety are the main objectives of a monetary policy.
Banks have to earn profits because if they don’t, they would not work as all the shareholders would sell off the shares if proper dividends are not earned. Hence they have to earn profits for their shareholders and at the same time satisfy the withdrawal needs of its customers. The main problem here comes is sticking the balance between liquidity and profitability as both contradict each other. This is the trade-off between liquidity and profitability.

Maximum safety or in simple language we can say liquidity can be attained only if the banks keep high amount of cash against the deposits they have held. But if they do this, this will not bring any profits for the banks. Thus, if the bank goes for maximum safety then they will have to sacrifice the profitability objective that is the dividends would be as per the requirements of the shareholders. Similarly if they go other way round that is they only keep on investing and trying to increase the profitability factor than they will have the problem if customer demands for cash. Hence it is very difficult for the banks to reconcile the twin objective of bringing the profitability factor and liquidity factor go hand in hand.
Trade-Off Between Liquidity And Profitability
A good banker should hence try to reconcile the twin conflicting objectives by actually working on a good portfolio management. This can be also done by analyzing the situation,