Introduction to Bank Balance Sheets

Introduction to Bank Balance Sheets Bank balance sheets report the assets, liabilities, and bank capital for an individual bank. The balance sheet identity is: Assets = Liabilities + Capital The assets are items that the bank owns. This includes loans, securities, and reserves. Liabilities are items that the bank owes to someone else, including deposits and bank borrowing from other institutions. Capital is sometimes referred to as “net worth”, “equity capital”, or “bank equity”. Bank capital are funds that are raised by either selling new equity in the bank, or that come from retained earnings (profits) the bank earns from its assets net of liabilities. The following is an example of a bank balance sheet: Assets Reserves & cash items Securities Loans Other assets TOTAL $9,000 $53,000 $124,000 $14,000 $200,000 Liabilities Checkable deposits Nontransaction deposits Borrowings $24,000 $122,000 $40,000 Bank capital TOTAL $13,000 $200,000 First, note that the total on the left side MUST ALWAYS equal the total on the right side. Also, the composition of this bank’s assets and liabilities is typical. To compare and to note any differences, compute the share of bank assets each item on the balance sheet accounts for and compare these figures to the ones shown in Table 1 (Chapter 9) of the text. Do the same for liabilities. Often, we will be more interested in how a bank balance sheet is changing, rather than the total assets and liabilities on the balance sheet. To analyze changes in the balance sheet, we use T-accounts. These are tables that look similar to the bank balance sheet, except that they only record changes in the balance sheet, rather than the totals. For example, consider the balance sheet above. Suppose that a bank customer, Cary, withdraws $1,000 in cash from his checking account at the bank. Assets Reserves (& cash items) Securities Loans Other assets -$1,000 No change No change No change TOTAL -$1,000 Liabilities Checkable deposits Nontransaction deposits Borrowings -$1,000 No change No change Bank capital TOTAL No change -$1,000 On T-accounts, the items that do not change are often no included. It is understood that they are not changing: Assets Reserves -$1,000 Liabilities Checkable deposits -$1,000 Notice, that when Cary withdraws cash, this reduces the bank’s vault cash (reserves = bank deposits with the central bank + vault cash). We could see this same change by looking at the bank’s balance sheet after this transaction takes place: Assets Reserves Securities Loans Other assets $8,000 $53,000 $124,000 $14,000 TOTAL $200,000 Liabilities Checkable deposits Nontransaction deposits Borrowings $23,000 $122,000 $40,000 Bank capital TOTAL $13,000 $200,000 Suppose that instead of withdrawing cash, Cary writes a check for $1,000 payable to a furniture store. When the furniture store deposits this check into its bank account, the furniture store’s bank clear the check. This means that it reports to a clearing house, such as the Federal Reserve to verify that these funds are available in the account upon which the check is drawn (Cary’s checking account). When the check clears, the clearing house will take these funds from Cary’s bank and give them to the bank that received the check (the furniture store’s check). This side of the transaction is recorded in reserves: Assets Reserves -$1,000 Liabilities Checkable deposits -$1,000 Note that for Cary’s bank, this is identical to Cary withdrawing cash from his checking account.