Question

Which of the following statement is untrue?

• A. A commercial bank may hold excess reserves as a source of liquidity.
• B. A commercial bank must remain solvent to be profitable in the long run.
• C. A commercial bank must hold liquid assets to meet unexpected deposit outflows.
• D. A commercial bank's secondary reserves consist of its excess reserves and marketable money securities.

Hint:

Primary reserves provide direct liquidity but do not earn interest. Secondary reserves are near-money instruments that provide both safety and interest income.

Answer 1

The Correct Option is D

Step 1: Understanding the Concept:
This question tests understanding of reserve management, banking liquidity, and the distinction between primary and secondary reserves in commercial banking.

Step 3: Detailed Explanation:
Let us analyze each statement individually:
- Option (A): Commercial banks hold excess reserves (liquid funds beyond the minimum reserves required by the central bank) to manage short-term liquidity needs. This statement is true.
- Option (B): Solvency (where a bank's total assets exceed its total liabilities) is essential for a bank's long-term survival, depositor confidence, and profitability. This statement is true.
- Option (C): Banks must keep a proportion of their assets in liquid form to honor unexpected cash withdrawals by depositors. This statement is true.
- Option (D): A commercial bank's reserves are categorized into primary and secondary reserves. Primary reserves consist of cash in the vault and required or excess reserves held at the central bank (non-interest-bearing or low-yield). Secondary reserves consist of highly liquid, short-term, interest-yielding marketable securities (such as Treasury bills) that can be quickly sold in the open market. Since excess reserves are part of primary reserves, the statement that secondary reserves consist of excess reserves is untrue.

Step 4: Final Answer:
The untrue statement is option (D).