Self liquidating paper theory

Self-liquidating loans are not always a good credit choice.

For example, they do not make sense for fixed assets, such as real estate, or depreciable assets, such as machinery.

This theory also states that whenever commercial banks make short term self-liquidating productive loans, the central bank should lend to the banks on the security of such short-term loans.The main theme of this theory is that the earning asset of a bank should be limited to short-term self liquidating productive loans that include self liquidating commercial paper or short term loan intended to provide the current working capital, which in itself is of a self liquidating nature.The advantage of the ‘self-liquidating theory’ of commercial bank asset is mainly derived from the fact that such loans are considered to liquidate themselves automatically out of the sale of goods covered by such a transaction.A business might use a self-liquidating loan to purchase extra inventory in anticipation of the holiday shopping season.The revenue generated from selling that inventory would be used to repay the loan.