Bank Assets, Liabilities, and Reserves

Bank Assets and Liabilities

  • Bank Assets: Resources a bank owns or controls that provide future economic benefits.
    • Loans and Advances: Money lent to customers (largest asset).
    • Cash and Cash Equivalents: Physical cash and liquid assets.
    • Investments: Securities like government and corporate bonds.
    • Property and Equipment: Real estate, office buildings.
    • Other Assets: Intangible assets, derivatives, receivables.
  • Bank Liabilities: Obligations the bank owes to others.
    • Deposits: Customer deposits (savings, checking accounts).
    • Borrowings: Loans from other financial institutions.
    • Debt Securities: Bonds issued to raise capital.
    • Other Liabilities: Accrued expenses, taxes payable.
  • Assets represent what the bank owns; liabilities represent what the bank owes.

Fractional Reserve Banking

  • Banks keep a fraction of deposits in reserve and lend out the majority.
  • Key Features:
    • Reserve Requirements: Banks hold a percentage of deposits in reserve.
      • Example: 10% reserve requirement means a bank holds 10% of deposits as reserves and can lend out 90%.
    • Money Creation: Lending and re-depositing creates new money.
    • Interest Rate and Lending: Banks earn interest on loans.
    • Deposit Expansion: Reserve requirements govern money creation.
      • Example: With a 10% reserve requirement, every $1 of initial deposit can lead to up to $10 of total money.
  • Risks and Criticisms:
    • Bank Runs: Too many withdrawals can deplete cash reserves.
    • Inflation: Too much money creation can decrease purchasing power.
    • Over-Leverage: Lending too much can cause problems if borrowers default.
  • Fractional reserve banking increases the money supply and encourages lending but carries risks of liquidity, solvency, and inflation.

Required Reserves

  • Minimum funds a bank must hold, as mandated by the monetary authority.
  • Formula: Required Reserves = Reserve Requirement Ratio × Total Deposits
  • Key Points:
    • Set by the Central Bank: To regulate money supply and ensure financial stability.
    • Prevents Bank Runs: Ensures liquidity for withdrawals.
    • Monetary Policy Tool: Adjust reserve ratio to influence lending.
      • Higher reserve ratio reduces money supply.
      • Lower reserve ratio increases lending.
    • Not Always Required: Some central banks set the reserve requirement to 0%.

Excess Reserves

  • Cash reserves a bank holds beyond the required minimum.
  • Formula: Excess Reserves = Total Reserves - Required Reserves
  • Key Points:
    • Central Bank Requirements: Banks must hold a percentage of deposits as required reserves.
    • Monetary Policy Impact: Central banks influence excess reserves by adjusting interest rates and reserve requirements.
    • Effects on Lending: High excess reserves indicate banks are holding cash.
    • Interest on Excess Reserves (IOER): Central banks pay interest on excess reserves to control liquidity.