Definition of Demand Liabilities
Demand liabilities are obligations that a bank must fulfill on demand from the depositor. These include deposits in accounts that are accessible at any time without prior notice, such as current accounts and savings accounts. They also include instruments like demand drafts which must be honored upon presentation.
Current Account
Definition
A current account is a type of deposit account primarily used by businesses, professionals, and entrepreneurs who require frequent access to their funds. It is designed for daily transactions, and it does not typically earn interest.
Features
- No Interest: Generally, current accounts do not earn interest.
- High Liquidity: Allows for unlimited withdrawals and deposits.
- Overdraft Facility: Often provides an overdraft facility, allowing withdrawals exceeding the available balance up to a specified limit.
- Cheque Book Facility: Comes with a cheque book for making payments.
- No Withdrawal Limits: No restrictions on the number of transactions or withdrawals.
Example
A small business owner, John, maintains a current account with ABC Bank. He frequently deposits customer payments and makes payments to suppliers from this account. On any given day, he can deposit $5,000 received from a customer and immediately write a cheque for $3,000 to pay a supplier. This flexibility is crucial for managing his daily business operations.
Savings Account
Definition
A savings account is a deposit account held at a bank or other financial institution that earns interest over time. It is intended for individuals looking to save money while keeping it accessible.
Features
- Interest Earned: Earns interest, typically lower than fixed deposits but higher than current accounts.
- Limited Withdrawals: Some savings accounts have restrictions on the number of withdrawals per month.
- Low Minimum Balance: Usually requires a low minimum balance compared to current accounts.
- Online Banking: Provides access to online and mobile banking facilities.
- ATM Access: Comes with a debit card for easy access to funds.
Example
Mary, a salaried employee, maintains a savings account with XYZ Bank. She deposits a portion of her salary every month and earns interest on her balance. She can withdraw money using her ATM card for daily expenses, transfer funds online, and save for future needs. For example, she might deposit $1,000 each month and earn 2% annual interest on her balance.
Demand Draft
Definition
A demand draft (DD) is a prepaid negotiable instrument issued by a bank, directing another bank or branch to pay a specific sum of money to the person named in the draft. It is often used for making secure payments.
Features
- Prepaid: The amount is prepaid by the purchaser, ensuring the payee receives the funds.
- Secure: Reduces the risk of non-payment as the funds are guaranteed by the issuing bank.
- Negotiable: Can be transferred or endorsed to another party.
- Non-Cancellable: Once issued, it cannot be cancelled unless lost or stolen.
Example
John needs to make a payment of $2,000 to a supplier in another city. To ensure the payment is secure and guaranteed, he purchases a demand draft from his bank, XYZ Bank. He pays the bank $2,000 plus a small fee, and the bank issues the DD in favor of the supplier. The supplier can then deposit the DD in their bank, which will collect the funds from XYZ Bank.
Role of Demand Liabilities in Banking
Liquidity Management
Demand liabilities are crucial for banks as they must ensure they have enough liquid assets to meet withdrawal requests. Banks maintain a portion of deposits as reserves and use the remaining funds for lending and investment purposes.
Example Scenario
ABC Bank has $100 million in current account deposits and $200 million in savings account deposits. On an average day, it experiences withdrawal requests totaling $10 million from these accounts. The bank must keep sufficient liquid reserves to handle these withdrawals while investing the remaining funds to earn interest and support lending activities.
Conclusion Demand liabilities, including current accounts, savings accounts, and demand drafts, are essential components of a bank’s financial structure. They provide customers with convenient access to their funds and support various financial transactions. Banks must manage these liabilities carefully to ensure liquidity and stability while optimizing the use of deposited funds for lending and investments. Understanding the features and uses of these demand liabilities helps in appreciating their significance in both personal finance and the broader banking system.
