Assets and Liabilities of Banks and Its Reserves

The article is about major assets and liability categories on a Bank’s Balance sheet and also related to reserve created by Bank and their impact. Now our discussion continue with some heading and subheading format are following –

Content of Bank Balance sheet:

Bank as a financial institution is by definition a complex organization and for those who do not know its operation it is not easy to understand. The Balance sheet of Bank consists of two parts. The left-hand side or assets side shows the position of the bank, the right-hand side or liability shows the debts which are same as other corporate Balance sheet. The identical difference created by Bank Balance sheet to other Corporate Balance sheet is categories.

Shift on the assets side:

Generally three category assets are shown in the bank balance sheet, there are as flows:

Loans:Loan is major source of income for any commercial bank. That will remain in the books until the maturity, i.e ‘hold to maturity’. Thus the same will remain in the books at purchase price until they are paid. If, for instance, the loan backed by mortgage of  house  then  increases or decreases in value, will not affect the balance sheet total of the bank in any way.

Securities:In general excess fund bank invest in a security, is booked as ‘available for sale’. The same assets the bank may maintain until maturity, but that may be sale before maturity. A major part of the assets has been placed in that category so that the financial institutions have their hands free should a buyer make an interesting bid.

Cash: Cash is typically the number one assets on a commercial bank’s balance sheet, because it is the most liquid asset for bank. For a bank, cash represents the money generated from interest-bearing accounts or money placed into financial investments.

Further the Banks should classify their assets into the following broad groups, are as flows –

(i) Standard Assets
(ii) Sub-standard Assets
(iii) Doubtful Assets
(iv) Loss Assets

1. Standard Assets: Standard Asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business.

2. Sub-standard Assets: The assets classified as sub-stander assets if, the current net worth of the borrowers / guarantors or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full and it remained non performing for a period less than or equal to 12 months.

3. Doubtful Assets: an asset is required to be treated as doubtful, if it has remained non performing for more than specified period. A loan classified as doubtful has all the weaknesses inherent as that classified as sub-standard.

4. Loss Assets: A loss asset is one where loss has been identified by the bank or internal or external auditors or by the Co-operation Department or by the Reserve Bank inspection but the amount has not been written off.

Shift on the Liability side:

Money deposited a bank by the depositorbecomes a liability of the bank. The bank has an obligation to pay the depositor the money deposited, on demand of the clients. The money deposited is an asset for the depositor.

Now consider the primary liability categories for a bank. Liabilities are, of course, what the bank owes. Being a representative bank, has three main categories of liabilities listed on the balance sheet at the right:

Transactions Deposits: In general the most important liability for bank is transactions deposits commonly known as checking accounts or checkable deposits. That make note, while checking accounts are assets for customers, they are liabilities for the Bank. The Bank owes these deposits to customers.

Other Types of Deposit: As a full-service bank, Bank has other types of deposits, too. Bank offers savings accounts,repurchase agreements, money market deposits,certificates of deposit, repurchase agreements, and a host of other accounts that find their way into the monetary aggregates.

Other Liabilities: Most banks also have a few other liabilities. Specifically Bank might borrow from sources other than typical household and business customers that provide deposits. Two common sources of funds are loans from other banks and loans from the Federal Reserve System.

Debt to Equity Ratio

The debt-to equity ratio is a financial ratio including the relative proportion of shareholders’ equity and debt used to finance a company’s assets. A measure of a company's financial leverage calculated by dividing its total liabilities by equity.

A high debt/equity ratio generally means that a company has been aggressive in financing its          growth with debt. This can result in of the additional interest expense. Hence a high debt-to-equity ratio result a lot of debt is used to finance for increase operation, therefore a huge interest burden generates and shareholders return reduce gradually.

The debt/equity ratio also depends on industry in which company operate. For example, capital-intensive industries, steel industries, cement industries generally maintain debt/equity ratio 2 or above. But in the case of commercial bank the same would be 8 or above.

The bank as a financial institution, they take investment from their customer and make loan to lender therefore generally the debt/equity is high.

Bank Reserve:

Bank reserve is the currency deposit which is not lent out by the banks to the clients. A small part of total deposit is held internally by the bank or deposit with the Reserve bank. The purpose of maintain the same by the financial institution is ensure that will be able to provide clients with cash upon deposit.

Every bank should maintain required reserve according to the guideline provide by the Reserve Bank in the form of cash in vault or if the vault cash is insufficient to satisfy the requirement, in the form of balance maintained either directly in Reserve Bank or in any liquid form. The bank is responsible for satisfying its reserve balance requirement by holding balances on average over a 14-day maintenance period in an account at the Federal Reserve.

Do most banks keep only the required reserves?

The main operation of a bank or financial institution is generating fund from investors and lend to the lender which is main source of income for the bank. Therefore it is clear that if bank make excess reserve then a fund crises arise. Thus it is common trend for every bank make as minimum reserve which is provide clients daily cash requirement.

From the above it is clear that most of the bank maintain only required reserve which is specify by the Reserve Bank or daily cash requirement.

Now we come to the last part of the assignment, where the question is changing reserve requirements can impact the bank’s profitability. It is very simple to understand, that main source of income for bank or financial institution is interest of lending and source of fund is deposit from clients. Hence bank should maintain as minimum reserve.

In the given example a client deposit $10,000 in savings account and reserve requirement is change from 5% yesterday to 10% today therefore, maintainable reserve increase by $500. The deference between interest rate of savings account and loans is 9%. Thus the Bank compromise profit of $45 in this year because of change in maintainable reserve percentage.