Management Notes

Reference Notes for Management

Loans and investment of a commercial bank constitute its

Loans and investment of a commercial bank constitute its

    1. Derivative deposits
    2. Primary deposits
    3. Secondary deposits
    4. All of the above

Correct Answer: a. Derivative deposits

Commercial banks are financial institutions that provide a range of services to individuals, businesses, and governments. Their operations involve both deposits and investments. Here’s a breakdown of each option and why they are correct or, not correct:

Correct Answer Explanation: a. Derivative deposits

Loans and derivatives of a commercial bank constitute its derivative deposits. Derivative deposits are financial instruments that are derived from underlying assets.

Loans and investments of a commercial bank constitute derivative deposits. Certificates of deposit (CDs), money market accounts, and other interest-bearing securities are examples of these types of financial products offered by commercial banks.

These products allow the bank to acquire funds that can be used to lend to borrowers or invest. As a result, the correct answer is (a), derivative deposits.

Why the other options are not correct

b. Primary Deposits:

Although primary deposits play an important role in a commercial bank’s operation, they do not directly make up the bank’s loans or investments. Generally, primary deposits refer to deposits made directly by customers into their accounts, such as savings accounts, checking accounts, and fixed deposit accounts.

Because the bank owes its customers these deposits, they are regarded as liabilities. The bank’s loans and investments, on the other hand, generate income and are used to fund its various activities. Therefore, option (b) is incorrect.

c. Secondary Deposits:

Option (c) suggests that loans and investments of a commercial bank constitute its secondary deposits. This is not accurate. Banks acquire secondary deposits from other financial institutions, such as other banks or the central bank, in order to meet reserve requirements.

It is important for a bank to maintain liquidity and meet reserve requirements. However, these deposits do not represent loans or investments it makes.

Here’s why “Secondary Deposits” could potentially be confusing:

  • Lack of Standardization: In the broader banking community and official financial terminology, “secondary deposits” is not a universally recognized term. This means that while it might be used in some contexts, it’s not as widely accepted as “primary deposits” and “derivative deposits.”
  • Potential for Confusion: Since it’s not a standard term, using “secondary deposits” might lead to confusion, especially when communicating with professionals in the finance and banking sector who are accustomed to the standard terminology.
  • Clarity and Precision: In finance and banking, precise terminology is crucial to ensure accurate understanding and communication. Standard terms like “primary deposits” and “derivative deposits” have well-defined meanings, making them more effective in professional discourse.

d. All of the above:

Option (d) claims that loans and investments of a commercial bank constitute all three types of deposits mentioned above (derivative deposits, primary deposits, and secondary deposits). In reality, this is not entirely accurate.

While derivative deposits are part of the loans and investments of a commercial bank, primary deposits represent liabilities rather than assets.

As secondary deposits are not loans or investments, but external sources of funds for the bank, option (d) is incorrect as well.

Accordingly, the correct option among the given choices is (a) Derivative deposits, which derive their value from the underlying assets.

Commercial banks’ loans and investments are made up of financial instruments known as derivative deposits. In spite of the importance of primary and secondary deposits to a bank’s operations, they do not constitute loans or investments directly.

In order to comprehend a commercial bank’s financial activities and overall functioning, one must understand the composition of its loans and investments.

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