Liquidity and solvency

Until recently a bank could be illiquid without being insolvent. Due to the Banking act of 1935 liquidity and solvency have become practically synonymous terms. The new legislation constitutes an abandonment of the commercial banking theory. This is, however, only a belated recognition of the fact that the bulk of bank assets consists of long-term paper. If these are "satisfactory assets" they can be liquefied at the federal reserve. Liquidity is therefore no longer a "natural" or "market" idea but an institutional, legal, or conventional concept. Commercial banking theory is a holdover from the period when banks presumably made only short-term loans and the central bank performed purely banking functions. But it is inadequate under existing circumstances when the central bank is presumed to liquefy actual portfolios and also to use its power to carry out monetary and economic policies. Under these circumstances, these require management and governmental intervention.