AP, IB, and College Microeconomic and Macroeconomic Principles 

What To Know About Bank Balance Sheets Before Test Day

Bank Balance Sheets

Updated 10/29/2021 Jacob Reed 

Bank balance sheets are an accounting of a bank’s liabilities and assets and can be one of the trickiest parts of learning macroeconomics. Below you will find a rundown of everything you need to know about bank balance sheets.

Bank Balance Sheet

1. What are the two columns on a bank balance sheet?

On the left side of a bank balance sheet, you will find the bank’s assets. Assets are all of the things the bank owns that are of value. They include required reserves (a percentage of demand deposits set by the Fed that cannot be loaned out), the excess reserves (funds available to be loaned out), loans (IOU’s from customers), securities (also called bonds), and physical assets (the building, computers, desks, etc). 

On the right side of the bank balance sheet, are the liabilities. These are all the things the bank owes. They are essentially a bank’s debts. They include demand deposits (checkable deposits owed to customers), other deposits (savings accounts, etc. owed to customers), other liabilities (debts, etc. owed by the bank), and owner equity (profit owed to bank’s owners).

On a bank balance sheet, assets always equal liabilities (they balance). If there is an increase in liabilities, there must be a decrease in a different part of liabilities, an increase in assets, or some combination of both.

2. What changes a bank’s balance sheet assets?

Reserves come from the money deposited by a bank’s customers. This is money that has not been loaned out. There are two types of reserves. Required reserves are a percentage of checkable deposits (checking account deposits) set by the Federal Reserve’s reserve requirement. Excess reserves is the amount of total reserves the bank can loan out. Required reserves plus excess reserves equals total reserves (sometimes just called reserves).

If the reserve requirement is 10%, and a customer deposits $1000 in their checking account, $100 (10%) will be required reserves and $900 will be excess reserves that can be loaned out. Total reserves for the bank will now be $1000. If the money was deposited in a savings account instead, all $1000 would go to excess reserves. That is because there is no reserve requirement on savings deposits.

Excess reserves will also increase when loans are paid back to the bank, securities are sold, physical assets are sold, or any of the liabilities are increased.

Required reserves only change when there is a change in the amount of demand deposits (checkable deposits). They always equal a percentage (set by the Fed’s reserve requirement) of checkable deposits.

Excess reserves will decrease whenever loans are made, securities are purchased, physical assets are purchased, or any of the liabilities are decreased.

Note: It is the excess reserves that is used with the money multiplier to calculate the creation of new money, loans, and deposits.

Note: Reserves are not counted in the M1 or M2 money supply.

Loans are IOU’s to the bank. They are on the assets side of the balance sheet because these promises to pay are worth the amount of the loan.

When the bank loans money to a customer, it will reduce excess reserves and increase loans. When a customer pays back a loan, it will increase excess reserves and decrease loans.

Securities (bonds) are pieces of paper which signify the right to be paid back for a loan. Securities are essentially loans to a business or the government.

When a bank purchases securities, excess reserves will decrease and securities will increase. When a bank sells securities, excess reserves will increase and securities will decrease. 

Note: If the Fed buys bonds from a bank, the money supply does not immediately increase as reserves are not counted in the M1 or M2 money supply. 

Physical Assets include the bank building, desks, chairs, computers, and even those pens with the chain attached. These are the physical objects (capital) the bank owns.

If the bank buys more physical assets, excess reserves will decrease as physical assets increase. If the bank sells physical assets, excess reserves will increase as physical assets decrease.

3. What changes a bank’s balance sheet liabilities?

Checkable Deposits are checking account deposits. These go up and down when a bank’s customers deposit or withdraw money to or from their checking accounts. It is a percentage of these checkable deposits (set by the Fed’s reserve requirement) that comprise the required reserves.

Other Deposits (sometimes listed as “savings deposits”) are deposits from customers that go into non-checking accounts. If a customer makes a deposit into their savings account, other deposits will increase (excess reserves will also increase). 

Note: There are no required reserves on other deposits.

Other Liabilities include loans and other debts owed by the bank. These must not be confused with loans found on the assets side of the balance sheet which are loans owed to the bank. If the bank takes out a loan, it will increase other liabilities and increase excess reserves.

Owner Equity is money (profit) owed to the owners (or shareholders) of the bank. If the bank collects interest when loans are repaid, that interest is added to owner equity as well as excess reserves on the assets side.

Is your head spinning yet? There are lots of components to a bank balance sheet and it can be a little tricky to figure out what causes each component to increase or decrease. If you are ready to practice it all, head over to the bank balance sheet game and see how well you understand.

Up Next: 
Review Game: Bank Balance Sheet Review Activity
Content Review Page: Monetary Tools

Bank Balance Sheets

     I just added the first macroeconomics review activity. Bank balance sheets have always been a place where my students have struggled. I hope this activity will help make understanding how events impact a bank’s balance sheet easier. 
     Here you will also find some tips and tricks regarding how to tackle a bank balance sheet question.