Understanding Bank Balance Sheets and Money Creation

Balance sheet

An accounting tool that lists assets and liabilities.

Asset

Item of value that a firm or an individual owns.

Liability

Any amount or debt that a firm or an individual owes.

Net worth

The excess of the asset value over and above the amount of the liability; total assets minus total liabilities.

Bank capital

A bank's net worth.

T-account

A balance sheet with a two-column format, with the T-shape formed by the vertical line down the middle and the horizontal line under the column headings for 'Assets' and 'Liabilities'.

Reserves

Funds that a bank keeps on hand and that it does not loan out or invest in bonds.

Federal Reserve requirement

The requirement that banks keep a certain percentage of depositors' money on 'reserve'.

Negative net worth

A situation where a bank's total liabilities exceed its total assets.

Loan defaults

A situation where borrowers fail to repay their loans.

Asset-liability time mismatch

The ability for customers to withdraw bank's liabilities in the short term while customers repay its assets in the long term.

Diversify

Making loans or investments with a variety of firms, to reduce the risk of being adversely affected by events at one or a few firms.

Secondary loan market

A market where banks sell some of the loans they make.

Government bonds

Debt securities issued by a government to support spending.

Money creation

The process by which the banking system can create money through making loans.

Interest income

The income earned by banks from the interest charged on loans.

Required reserves

The amount of reserves that a bank is required to hold, expressed as a percentage of its deposits.

Loan to Hank's Auto Supply

A specific loan of $9 million made by Singelton Bank.

Cashier's check

A check issued by a bank on its own funds, guaranteed to be paid.

First National Bank

A bank that receives a $9 million deposit from Hank's Auto Supply and must hold required reserves.

Required reserves

The minimum amount of reserves a bank must hold against deposits, in this case, $900,000.

Excess reserves

The amount of reserves that a bank holds over and above the required reserves.

Loan to Jack's Chevy Dealership

An $8.1 million loan made by First National Bank after holding required reserves.

M1 money supply

The total amount of money available in the economy, including cash and demand deposits.

Money multiplier

A formula used to determine the total amount of money that can be created in the banking system, calculated as 1 / Reserve Requirement.

Reserve Requirement

The percentage of deposits that banks are required to hold as reserves.

Change in M1 money supply

The increase in the money supply resulting from loans made by banks, calculated using the money multiplier.

Macroeconomic conditions

Economic factors that can influence a bank's decision to hold reserves.

Federal Reserve

The central bank of the United States that can adjust reserve requirements as a policy move.

Recession

An economic downturn during which banks may hold a higher proportion of reserves due to increased risk of loan defaults.

Deposits

Funds placed into a bank account, which can be loaned out by the bank.

Multi-bank system

A banking system where multiple banks operate, allowing for the re-depositing and lending of money.

Cash deposits

Physical currency deposited into a bank that can be loaned out.

Bank loans

Funds lent by banks to borrowers, which can then be deposited and re-loaned.

Hank's Auto Supply

A business that receives a cashier's check for $9 million from Singelton Bank.

Second National Bank

A bank where Jack's Chevy Dealership deposits its loan.

Financial system

The system that facilitates the flow of funds between savers and borrowers.

Lending

The act of providing funds to borrowers with the expectation of repayment.

Depository institutions

Financial institutions that accept deposits and provide loans.