Question

Briefly explain why keeping excess reserves in banks is considered to be expensive?

Why do banks prefer to manage liquidity risk by adjusting liability side instead of assets?

 

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Answer 1

Explanation:

Banks operate by providing loans to people from the money people deposit in banks and take out the profits out of the interest rate. If a bank keeps on stacking its reserves/deposits and does not give loans, ultimately they will be squeezing their profit and this is an expensive strategy.

Secondly, liquidity money is easier to manage than asset because assets usually are not easy to sold or exchange than money, that is why bank usually gives loan in terms of money not assets