It is simple understanding that due to increase of classified loans, the bank has faced to liquidity crisis. However, when loans go bad they have some adverse effects on the financial health of
banks. Banks make adequate provisions and
charges for
bad debts which impact negatively on performance. The provisions
for bad loans
reduce total loan portfolio of
banks and as such affects
interest
earnings on such assets. This constitutes huge cost, as it makes a liquidity crisis for
the
banks.
On other
hand, when banks will go into liquidity crisis, they try to borrow from
inter-bank call money at a high interest rate.
The inter-bank call money market is an overnight market in meeting bank‘s immediate liquidity needs and reserve deficiencies. Hence, an important task of the call money market is to facilitate liquidity management in the inter-bank market. The orderly and stable functioning of the inter-bank call money market is
important to minimize liquidity risk in the banking system as
a whole.
So
that the banks will penetrate to call money at high interest rate to maintain
their adequate liquidity due to loan classification and keeps provision in this
same.