Understanding Bank Balance Sheets: A Comprehensive Guide to T-Accounts

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economics bank balance sheets also known as tea accounts are a visual record of fractional Reserve banking within a bank

these ledgers display how Banks use any deposits and available funds to create reserves and new loans for the purpose

of lending put simply it shows the money that has been deposited into a bank and how the bank is using it for many

students bank balance sheets are the bane of their existence when they see those T accounts on an exam question

it's like it must be taken deep into Mordor and cast back into the fiery Chasm from whence it came but in this

video I'm going to show you everything you need to know to not only understand and master te accounts but to conquer

your fear of it it is a gift why thank you borr just trying to help this is a bank balance sheet the

activities of all banks are divided into two categories liabilities and assets liabilities are the financial

obligations that a bank must pay to an entity to whom they are entitled they can include demand deposits account

Investments and Equity assets are the possessions owned by or credited to a bank that can be collected and liquefied

Into Cash assets can include required reserves excess reserves outstanding loans or Investments and other

Securities when demand deposits are made fractional Reserve banking generates reserves for banks these reserves can be

turned into loans and other assets to repay liabilities Banks can collect and liquefy their assets into cash and cover

any and all liabilities owed to various entities the key to bank balance sheets is well

balance when you're analyzing a te account the numbers can become a confusing mess what's going where and

how does this affect that so let me give you some tips to figuring it all out remember these easy tips and it'll all

become a lot simpler one the total sum of all liabilities must always equal the total sum of all assets when you add up

all the demand deposits equity and any other liability that the Bank owes the sum should always equal the total sum of

all reserves loans Securities and other assets that the bank owns two a change made on one side of

the t account will result in an equal change to the other assets are created from available liabilities meaning that

the size of the bank's available assets is limited by the size of the liabilities that made them possible as a

result a change in liabilities will result in an equal change in assets and vice

versa three regardless of changes in assets and liabilities the required reserves held by the bank will always

align with the reserve ratio set by the fed the te account can become complex you might start seeing things like

owner's equity building improvements and investment Securities listed under liabilities and assets just cut through

it all and keep it simple regardless of all the distraction remember that the bank will always hold a portion of their

demand deposits in required reserves that align with the reserve ratio use this as an anchor when solving any bank

balance sheet questions okay here we go let's look at how deposits and withdrawals affect bank

balance sheets when a demand deposit is made at a bank the deposit becomes a liability

because the bank is obligated to cover that deposit if it is withdrawn at any time however it also leads to the

creation of assets for the bank in the form of reserves and new loans assume that a $1,000 cash deposit is

made into a savings account at First Federal bank now assume that the Federal Reserve is set the reserve ratio at 10%

and First Federal Bank holds no excess reserves as liabilities increase by $1,000 due to the new demand deposit

First Federal Bank can now create $1,000 in new assets the bank will hold $100 or 10% of the $1,000 demand deposit in

required reserves and will loan out $900 in excess reserves at this point a $1,000 increase in

liabilities has created $1,000 in assets for First Federal bank and both sides of the te account total

$1,000 in addition the bank is holding 10% of its $11,000 of demand deposits in required reserves and the remaining 90%

are currently in the form of outstanding loans now assume that a second $11,000 cash deposit is made into a checking

account at First Federal Bank the bank's liabilities increased to a total of $2,000 as demand deposits increased by

$1,000 and First Federal can now create an additional $1,000 worth of assets the bank will hold $100 or 10% of the $1,000

demand deposit in required reserves increasing the bank's required reserves to a total of

$200 First Federal will then loan out the $900 of excess reserves from the deposit increasing the bank's

outstanding loans to $1,800 at this point a $11,000 increase in liabilities has created $1,000 in

assets for First Federal bank and both sides of the te account total $2,000 in addition the bank is holding

10% of its $2,000 of demand deposits in required reserves and the remaining 90% are currently in the form of outstanding

loans now assume that a $500 cash deposit is made into a checking account at First Federal Bank the bank's

liabilities increase to a total of $2,500 as demand deposits increase by $500 and First Federal can now create an

additional $500 worth of assets the bank will hold $50 or 10% of the $500 demand deposit in required reserves

increasing the bank's required reserves to a total of $250 First Federal will then loan out

the $450 of excess reserves from the deposit increasing the bank's outstanding loans to

$2,250 at this point a $500 increase in liabilities has created $500 in assets for First Federal bank and both sides of

the te account total $2,500 in addition the bank is holding 10% of its $2,500 of demand deposits in

required reserves and the remaining 90% are currently in the form of outstanding loans this process continues every time

a demand deposit is made into First Federal Bank it's that easy when a withdrawal is requested by a

depositor the bank is obligated to pay back a demand deposit or other liability that means that the bank must cover the

withdrawal by liquifying assets it holds in reserves and by calling in any outstanding loans owed to it by debtors

this will lead to a change in the bank's assets that will equal the withdrawal from the bank's

liabilities assume that the Federal Reserve has set the reserve ratio at 10% now assume that Community Banks

liabilities equal $5,000 in demand deposits and its assets equal $5,000 $500 is held in required reserves

$4,500 are currently held in outstanding loans and Community Bank holds no excess reserves suppose that a depositor

requests a withdrawal of $1,000 from their checking account at Community Bank the bank must generate $1,000 in M1 cash

from its current assets to cover this withdrawal and it can start with the cash reserves it has on hand if the

$1,000 withdrawal decreases the bank's liabilities to a total of $44,000 the bank is only required to hold 10% of its

demand deposits or $400 in required reserves meaning that it can take $100 from its required reserves on hand to

help cover the withdrawal to cover the remaining balance of the withdrawal the bank will call in $900 from its

outstanding loans reducing the bank's outstanding loans to $3,600 and decreasing the bank's assets

to a total of $4,000 at this point a $1,000 decrease in liabilities has led to a $1,000

decrease in assets for Community Bank and both sides of the te account total $4,000 in addition the bank is holding

10% of its $4,000 in demand deposits in required reserves and the remaining 90% are currently in the form of outstanding

loans now suppose that a second depositor withdraws $500 from their savings account at Community Bank the

bank must generate $500 in M1 cash from its current assets to cover this withdrawal and it can start with the

cash reserves it has on hand if the $500 withdrawal decreases the bank's liabilities to a total of

$3,500 the bank is only required to hold 10% of its demand deposits or $350 in required reserves meaning that

it can take $50 from its required reserves on hand to help cover the withdrawal to cover the remaining

balance of the withdrawal the bank will call in $450 from its outstanding loans reducing the bank's outstanding loans to

$3,150 and decreasing the bank's assets to a total of $3,500 at this point a $500 decrease in

liabilities has led to a $500 decrease in assets for Community Bank and both sides of the te account total

$3,500 in addition the bank is holding 10% of its $3,500 in demand deposits in required reserves and the remaining 90%

are currently in the form of outstanding loans now suppose that a third depositor withdraws $2,000 from their savings

account at Community Bank the bank must generate $2,000 in M1 cash from its current assets to cover this withdrawal

and it can start with the cash reserves it has on hand if the $2,000 withdrawal decreases the bank's liabilities to a

total of $1,500 the bank is only required to hold 10% of its demand deposits or $150 in required res

reserves meaning that it can take $20000 from its required reserves on hand to help cover the withdrawal to cover the

remaining balance of the withdrawal the bank will call in $1,800 from its outstanding loans reducing the bank's

outstanding loans to $1,350 and decreasing the bank's assets to a total of

$1,500 at this point a $2,000 decrease in liabilities has led to a $2,000 decrease in assets for Community Bank

and both sides of the te account total $1,500 in in addition the bank is holding 10% of its $1,500 of demand

deposits in required reserves and the remaining 90% are currently in the form of outstanding loans this process

continues every time a demand deposit is withdrawn from Community Bank see not so hard the process changes a bit however

when banks have other assets that they can liquefy to cover withdrawals for example when a bank holds excess

reserves or investment Securities it has the ability to cover some or all withdrawals without without having to

call in loans remember that Banks prefer to keep loans outstanding because debtors are paying the bank an interest

rate to borrow money when a loan is called in the bank loses the ability to collect interest on that loan and

therefore loses potential profits as a result banks will use excess reserves or investment Securities first to cover

withdrawals and will only call in loans if they lack adequate reserves to pay back

deposits assume that the Federal Reserve has set the reserve ratio at 25% now assume that United bank's

liabilities equal $88,000 in demand deposits and its assets equal $8,000 $2,000 are held in required

reserves $4,000 are currently held in outstanding loans and United Bank holds $2,000 in excess reserves suppose a

depositor requests a withdrawal of $2,000 from their savings account at United Bank the bank must generate

$2,000 in M1 cash from its current assets to cover this withdrawal and it can start with the cash reserves it has

on hand if the $22,000 withdrawal decreases the bank's liabilities to a total of $6,000 the bank is only

required to hold 25% of its demand deposits or $1,500 in required reserves meaning that it can take $500 from its

required reserves on hand to help cover the withdrawal to cover the remaining balance of the withdrawal the bank will

use $1,500 of the cash it has on hand in excess reserves reducing the bank's excess reserves to $500 and decreasing

the bank's assets to a total of $6,000 the bank was able to cover the entire withdrawal by using cash reserves

it had on hand meaning it didn't have to call in any outstanding loans or lose the ability to earn profits through

lending at this point a $2,000 decrease in liabilities has led to a $2,000 decrease in assets for United Bank and

both sides of the te account total $6,000 in addition the bank is holding 25% of its $6,000 of demand deposits in

re IR reserves and the remaining 90% are currently in the form of excess reserves and outstanding

loans now assume that instead of holding cash in excess reserves United Bank used $2,000 of its liabilities to purchase

investment Securities in the form of Treasury bonds suppose the same depositor requests a withdrawal of

$2,000 from their savings account at United Bank the bank must generate $2,000 in M1 cash from its current

assets to cover this withdrawal and it can start with the cash reserves it has on hand and if the $2,000 withdrawal

decreases the bank's liabilities to a total of $6,000 the bank is only required to hold 25% of its demand

deposits or $1,500 in required reserves meaning it can take $500 from its required reserves on hand to help cover

the withdrawal to cover the remaining balance of this withdrawal the bank will sell $1,500 worth of its Bonds in the

open market essentially liquefying those assets into M1 cash to cover the rest of the withdrawal this reduc R es the

bank's investment Securities to $500 and decreases the bank's assets to a total of

$6,000 the bank was able to cover the entire withdrawal by using cash reserves it had on hand and by selling the bonds

it owned meaning it didn't have to call in any outstanding loans or lose the ability to earn profits through lending

at this point a $2,000 decrease in liabilities has led to a $2,000 decrease in assets for United Bank and both sides

of the te account total $6,000 in addition the bank is holding 25% of its $6,000 of demand deposits in

required reserves and the remaining 90% are currently in the form of investment Securities and outstanding loans in both

cases United Bank did not have to call in any of its outstanding loans to help cover withdrawals instead it simply used

excess reserves it had on hand in its vaults or liquified its assets to generate cash to help cover the

withdrawal in the meantime United Bank goes on collecting profit from the interest at earned on the loans it's

issued and that's bank balance sheets be sure to subscribe to the channel by hitting the red button below so you can

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