Self liquidating paper theory

An explanation of bank liquidity described by Adam Smith: short-term loans advanced to finance salable goods on the way from producer to consumer are the most liquid loans the bank can make.

A bank that issues its money in exchange for short-term assets that are payable in 30 days will thus match the maturities of its notes (30 days) to those of its assets, and it will avoid illiquidity and possible insolvency.The repayment schedule and maturity of a self-liquidating loan are designed to coincide with the timing of the assets' income generation.These loans are intended to finance purchases that will quickly and reliably generate cash.When business started growing and the requirements of trade increased, banks were able to capture additional reserves by rediscounting bills with the central banks.Self liquidating (real bills doctrine) theory is a traditional and conservative banking theory.Efforts have been made by economists to resolve these contradictions by laying down some theories from time to time.


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