The Bank Balance Sheet

Banks provide many deposit and lending services. Lending services appear on the asset side of a bank's Balance sheet, while deposit activities appear on the liability side.

Assets

Assets are broken down into the following categories: loans, investments,and cash reserves.

Loans

Loans are funds lent to borrowers for specified periods of time. They are generalló repayable at a scheduled maturity date and at a certain interest rate. A loan is usually tailored by a bank to meet the needs of an individual borrower. Thus, most loans are unique and not very marketable. In 1990, loans accounted for 62% of bank assets, and revenues from interest payments on loans were the major source of bank earnings. The major types of loans were business loans (which accounted for 27% of total loans), mortgage loans on residential and commercial real estate (37%), consumer loans (18%), and loans to other financial institutions (9%). While the per centages tend to vary according to bank size and location, large city banks tend to make more business loans, while smaller, rural banks lean toward consumer and agricultural loans.

Investments

Investments on bank balance sheets are loans made in làrgå, standard amounts to large, well-known borrowers, such as the U.S. Treasury and sizable corporations.In return, the bank receives bonds issued by the borrower. Unlike loans, investments or bonds tend to be marketable and hence provide banks with greater liquidity. Like loans, bonds yield interest income; although, because the risks are generally lower than for loans, they yield less. In 1990, investments accounted for 18% of bank assets. Most bonds are bought from the federal government or from state and local governments. Cash Reserves. Banks hold cash reserves to meet demands lor deposit outflows quickly and to satisfy the cash reserve requirements imposed by law by the Federal Reserve. The cash may be held in the banks' own vaults or on deposit at other banks or at Federal Reserve banks. Because cash reserves do not yield interest or other income, banks try to minimize the amount they hold. As of 1991 the Federal Reserve applied its reserve requirements only against demand deposits.

Liabilities

Liabilities on a bank's balance sheet fall into the following categories: deposits, borrowed funds, and capital.

Deposits

Deposits are funds lent to the bank, for varying lengths of time, by households, businesses, and government units. The bank pays for the funds by offering interest, rendering certain services, or both. Services rendered include processing checks, maintaining records, and providing periodic statements to depositors on the statys of their accounts. Deposits are generally classified as those that can be withdrawn and transferred to a third party by check ("transaction deposits"), and those that cannot.

Traditionally, checks could be written only on demand deposits (deposits payable on demand), on which the payment of interest was prohibited. More recently, consumer deposit holders have been permitted to write checks on interest-bearing accounts called negotiable order of withdrawal (NOW) accounts, and in limited numbers on money-market deposit (MMD) accounts. Noncheckable deposits generally have a specific maturity date or carry a provision (rarely imposed) for a waiting period before repayment. These accounts are referred to as time deposits, and they yield a higher interest rate. For individuals, time deposits generally come in the form of either savings accounts or consumer certificates of deposit (CDs). For businesses, time deposits are usually negotiable certificates of deposit in amounts of a million dollars or more. In 1990 27% of all bank deposits were in the form of transaction deposits, and 73% in the form of time deposits.

Borrowing

Banks borrow funds primarily from other banks (called "Fed" funds because the funds are reserves on deposit with the Federal Reserve) or from the Federal Reserve itself through its own lending operation (which is known as the discount window). These Fed fund loans generally come in large denominations and for short periods of time, frequently only overnight.

Capital

Capital represents funds invested by the owners of the bank. Generally, it is in the form of equity or stock and is issued in shares. Shareowners do not receive a fixed interest rate. Rather, they participate in the earnings and losses of the bank. If the bank generates earnings, shareholders benefit from increases in the value of their shares. Sometimes they also receive dividends. If the bank suffers losses, shareholders lose some of their investment. If the losses are large enough to wipe out the total value of the capital, the bank becomes insolvent, and shareholders lose both their total investment and control of the bank. Capital is a buffer that protects depositors from losses, and the bank from failure. In 1990, U.S. banks had capital equivalent to 7% of their assets.

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