If you take a look at a bank’s balance sheet, you wouldn’t find the inventory line in it. However, it doesn’t mean banks do not have inventory. Like other consumer service industries, banks do not have tangible inventory.
Cash reserves at bank vaults and deposited with the central banks are the only physical inventory banks hold. Surprisingly, the cash held by banks only accounts for a small percentage of total assets, as low as 2% only in some cases.
The main items in a bank’s inventory include cash, securities, and bank loans. Several factors including the FED reserve requirement can have an impact on a bank’s cash reserves and hence its profitability.
Let us understand the concept of inventory in a bank.
What is Inventory in a Service Industry?
The concept of inventory is usually associated with the manufacturing industry. Businesses with tangible assets hold physical inventory. The concept is easier to understand as the inventory can be managed or tracked easily.
In a service industry like banking, there isn’t much physical inventory. The service industry relies on its services, patents, trademarks, goodwill, and intangible assets to serve consumers. Hence, accounting for inventory in a service industry is a complex task.
Banks also rely on customer services and intangible products to generate profits. For instance, a bank’s largest pool of profits comes from lending money to its customers. Banks also make money through investments in securities.
Typical service industries like banking rely heavily on intangible products. Banks rely on their lending products such as personal loans, mortgages, credit card products, business financing, credit lines, and so on.
Do Banks have Inventories?
As discussed above, banks only have cash reserves as inventory. However, cash held with banks accounts for a small fraction of its total assets. Banks need to invest the collected cash from customers to earn interest.
Banks retain physical cash stocks at their branch and central branch vaults. Banks need to maintain a minimum cash reserve ratio as well. Hence, banks look to balance the need for statuary compliance and investing activities.
A key distinction between banks holding cash at vaults and central banks is the potential earnings with the latter option. When banks hold cash reserves with the central bank, they earn interest on it. Hence, banks would prefer holding their inventory with central banks rather than keeping it at their disposal.
Other key components of a bank’s inventory are securities and bank loans. Banking services and products can also be accounted for as inventory of a bank. However, the customer satisfaction and compliance metrics are difficult to measure. Banks can only use benchmarking to assess the compatibility of these intangible inventory items.
Cash Reserves as Bank Inventory
Central banks almost around the world require commercial banks to maintain a certain percentage of cash reserves. The FED announces the reserve rate for commercial banks in the US. The reserve requirement can change from time to time. For instance, last year due to pandemic hardships, the FED lowered the reserve requirements to zero temporarily.
When banks collect cash from retail and corporate customers, they can choose to retain the cash stock or invest it. However, since banks need to comply with statutory requirements, they need to maintain cash reserves adequately.
The FED requires large commercial banks to maintain at least 10% of their assets as cash reserve with the FED. Smaller banks have the condition of maintaining 3% and 0% depending on their total assets.
Cash held by banks in-branch vaults, ATMs, and centralized vault systems also account for the FED reserve requirement. However, since banks earn interest on cash deposited with central banks, they would prefer this option.
Other Forms of Inventory in the Banking Industry
Although cash is the main inventory item for banks, it accounts for a small proportion of the assets of a bank. Banks hold intangible assets or inventory that they sell (invest) to earn profits.
Marketable securities refer to fixed-income and equity instruments held for investments. These securities form a considerable proportion of assets held by a bank along with bank loans.
Banks hold marketable securities for generating profits as well as maintaining liquidity. Hence, these intangible assets can be termed as an important inventory part for banks.
Some common types of securities held by banks include:
- Equity Securities: These can be in the form of common stocks or preferred stocks held by banks. Banks also often invest in high-risk equity investment instruments such as IPOs.
- Debt Securities: investment grade bonds such as municipal bonds and T-bills are common debt securities held by banks. Also, banks invest in debentures issued by the corporate sector.
- Commercial papers, notes, and other short-term securities can be classified as money market securities. Banks hold a proportion of their investments in money market securities to boost liquidity.
Banks earn profits by lending money to borrowers. They also pay investors for investing money in their products. The net difference between the interest paid and earned by banks is the profit for banks.
Loans represent a significant proportion of assets held by a bank. Lending rates, cash reserve requirements, and economic factors all play a crucial role in the lending capabilities of banks.
Banking services and products can be seen as an important part of the intangible or invisible inventory of banks as well. Since banks sell consumer services and intangible products such as loans, deposit schemes, credit cards, and mortgages, these are difficult to account for in standard terms.
Banks can measure the effectiveness of their services through benchmarking. They can compare their market and customer share with historic results as well as industry standards.
How Do Banks Manage Their Cost of Inventory Management?
Banks have started to outsource cash supply management. Specialized companies have offered low-cost and efficient cash supply management solutions to the banking industry.
Cash held at branch vaults, movement to and from centralized vaults, and cash supply to ATMs are costly ventures for banks. Outsourcing these cash supply tasks have reduced the inventory management costs for banks overall in recent years.
Banks have been keen to invest in secured marketable securities that are backed by collateral. However, it’s inevitable for banks to invest in unsecured securities since they offer higher risk-reward options.
Automation of regular tasks and use of the modern technology have helped banks reduce their costs of operations as well. Thus, the evolution of banking services also helps bank reduce their inventory costs for invisible inventory items such as customer services.
How the FED Reserve Requirements Affect Banks?
Since banks have to comply with the FED reserve requirements, any changes in the regulations can affect their profitability and liquidity. For instance, the FED reduced the reserve requirements to zero temporarily during the pandemic last year.
When the FED or central banks around the world change cash reserve requirements, it affects the banks’ abilities to lend or borrow money. Thus, interest rates fluctuate with a move in the cash reserve requirement. Hence, the cost of key inventory items (cash) for banks also changes with a change in the cash reserve requirements.
Banks hold cash reserves as a key inventory item. Other forms of inventory for banks include securities, loans, and banking services. Banks can hold cash reserve at vaults or invest it with the central banks.
Banks can take several measures to reduce their cost of inventory management including outsourcing cash supply management, efficient use of technology, and investments.