Bank Balance Sheet Essay

Dissecting a Bank’s Balance Sheet

In this essay we would investigate the balance sheet of XY Bank and try to find out how a bank’s balance sheet is different from that of a company. We would also describe why bank managers prefer loans over securities and whether 4% cash reserves of the bank are adequate for its capital-adequacy management.

Why Banks’ Balance Sheet differ from that of a Typical Company

First, let us discuss why and how a bank’s balance sheet is different from that of a company. For that we would have to look at the underlying business models of a typical bank and a typical company. A bank’s sole purpose is to earn optimized profits by leveraging the interest rate spreads on the assets it owns against the liabilities it owes.

In other words its loans (mortgage, corporate and other consumer loans) should constitute the largest percentage of its total assets. We can observe this in XY’s balance sheet where loans comprise 64% of the total assets’ portfolio. The golden rule for banks is to ‘lend long and borrow short’ (Wright & Quadrini, 2009, p. 192) so most of its loans amount would constitute long term loans and majority of its deposits and borrowings would be short term. Further a bank mostly procures its funds from individuals and corporates in the form of demand and term deposits. This can be seen in the balance sheet where deposits comprise 61% of sources of funds. A bank also obtains short term loans/advances from other banks and the central bank. But this does not constitute the majority of its sources of funds. The 28% borrowing amount is testament to

Banks earn the substantial part of their earning and profits from these long term loans. Securities are merely there to act as a contingency buffer for banks’ liquidity requirements while at the same time earning interest. Securities, as aforementioned, are interest-earning part of a bank’s reserves.

Conclusion

We briefly discussed how and why a bank’s balance sheet is different from that of a company. We also described and explained various segments and percentages of the balance sheet in order to emphasize the critical importance of loans over other categories. Finally, we also detailed how a bank efficiently balances and prioritizes her liquidity management requirements. Let us move to the next stop of our academic journey for yet another revealing topic next week.