Banking Basics

balance sheet

presents financial information on a bank’s assets, liabilities, and equity capital

balance sheet identity (accounting equation)

total assets = total liabilities + equity capital

value cash

composed of the currency and coins needed to meet customer withdrawals (i.e: cash stored in bank vaults)

deposits at federal reserve

used primarily to meet legal receive requirements, to assist in check clearing, wire transfers, and the purchase or sale of treasury securities

deposits at other financial institutions

used to purchase services from other financial institutions (i.e: correspondent banking)

cash items in process of collection

deposited checks written on an account at another bank whose funds have not yet been received/cleared

reserve requirment

the regulation that for every dollar of checkable deposits at a bank, a certain fraction must be kept at reserves

reserves

value cash + deposits at federal reserve

secondary reserves

short term US Treasury (high liquidity)

unearned income

the amount of income that the bank received on a loan from a customer but has not yet recorded as an earned income

allowance (reserve) for loan and lease losses

an estimate of the loans and leases that will not be repaid to the bank

transaction accounts (checking accounts)

subject to reserve requirements

Federal Deposit Insurance Corporation (FDIC)

250,000 per depositor per insured bank for each account ownership category

demand deposit accounts

non-interest bearing checkable deposits

NOW accounts

interest-bearing checkable deposits

bank’s equity capital

represents the bank’s net worth, which equals the difference between total assets and total liabilities (accounting equation)

reserves (formula)

reserves = vault cash + deposits at federal reserve

reserves required (formula)

reserves required = transaction accounts * reserves required in %

excess reserves (formula)

excess reserves = reserves - reserves required

off-balance sheet (OBS) items

contingent assets and liabilities that may affect the bank’s B/S and/or I/S

OBS activity categories

1. loan commitment

2. loan sale

3. derivative securities

loan commitment

contractual commitment by a bank to loan a customer a certain max amount at given interest rate terms

loans sold

loans that originated by a bank and then sold to other investors

• can be sold with recourse or without recourse

sold without recourse

then loan sales have no OBS contingent liability implications for the bank; the buyer bears the full risk of loss

sold with recourse

must be returned to the bank if the credit quality of the loans deteriorate

derivative contracts

future, forward, swap, option, and other derivative positions taken by the bank for hedging or other purposes

total interest income

interest income earned from the bank’s assets

earning assets

• loans and leases

• investment securities

total interest expense

interest paid to the bank’s liabilities

“interest-bearing liabilities”

• deposits (excluding demand deposits)

• borrowed funds

net interest income (formula)

net interest income = total interest income - total interest expense

extraordinary items

events or transactions that are both unusual and infrequent

return on asset (ROA)

determines the net income produced per dollar of asset (i.e: a measure of profitability linked to the asset size of the bank)

equity multiplier (EM)

measures the dollar value of assets funded with each dollar of equity payments (i.e: measure of leverage)

profit margin (PM)

measures the ability to control expenses and thus its ability to produce net income from its operating income

asset utilization (AU)

measures the extent to which the bank’s assets generate revenue

spread

measures the difference between the average yield on earning assets and the average cost of interest-bearing liabilities

overhead efficiency

measures the ability to generate noninterest income to cover noninterest expense