Kenneth R. Szulczyk
asset. They include three items. First, a bank holds vault cash, which is simply cash the bank
holds in its safe. A bank has money, so a bank can pay depositors cash when they come to the
bank to withdraw funds. According to Table 1, U.S. banks held $1.4 trillion in December 2013.
Second, a bank holds deposits at another bank because these deposits can aid in check clearing
and in foreign exchange transactions. Finally, the bank holds deposits at the Federal Reserve. A
central bank forces banks to hold a percentage of the bank’s checkable deposits, which are
required reserves. The Federal Reserve wants to ensure that banks have enough reserves to meet
depositors’ withdrawals.
Marketable securities are the second asset. Banks hold U.S. government securities, such as
T-bills, T-notes, T-bonds, and municipal bonds. (Banks can hold mortgage-backed securities,
which we discuss under Securitization). These securities are very liquid that we sometimes call
secondary reserves. If banks need cash reserves fast, then the bank can sell its marketable
securities quickly. U.S. banks held roughly $2.5 trillion in December 2013 as shown in Table 1.
Loans are the third asset and the most important source of income. In December 2013,
loans represented roughly 60 % of total assets. Unfortunately, loans have a greater probability of
default than other assets, lower liquidity, and more information costs. However, banks are
compensated for this risk by earning higher interest rates. Loans earn higher interest rates than
marketable securities. According to Table 1, U.S. banks lent $1.3 trillion as commercial and
industrial loans, $3.5 trillion for real estate, and $1.2 trillion for consumer loans. Fifty-four
percent of consumer loans comprise credit cards.
Federal funds market can be a bank asset or a liability. Each bank must hold reserves in the
form of vault cash plus deposits at the Federal Reserve. The Federal Reserve sets the percentage
of reserves a bank must hold because reserves help ensure banks have cash to meet depositors’
withdrawals. Federal funds market is one bank with excess reserves at the Fed can lend these
reserves to another bank that is short in reserves. These loans are usually overnight, where banks
transfer electronically the funds. Consequently, Federal Funds become an asset for the lending
banks and a liability to the borrowing banks. Referring to Table 1, banks lent $81.8 billion to
other banks in the Federal Funds in December 2013. Federal funds rate reflects the interest rate
for this market.
Table 1 contains two items that are not self-explanatory. U.S. banks estimated $123.3
billion in bad debt and losses during December 2013. We labeled this loss - Allowance for loan
and lease losses. Furthermore, U.S. banks held 119.9 billion in trading assets that banks use in
derivatives trading. Finally, the remaining bank’s assets earn no interest and include physical
capital, such as the bank’s buildings, computers, and other equipment, which totaled roughly $1
trillion.
Bank's net worth or capital becomes the last item on the bank’s balance sheet. Capital
equals total assets minus total liabilities. All banks organize themselves into corporations. A
corporate bank’s capital is the stock sold to the investors plus the bank’s profit. Creditors
consider capital important because it provides a financial cushion for loans and obligations. If a
company bankrupts and cannot repay a loan, the creditors have the first priority of the
company’s assets, while the shareholders have the last priority. A positive capital ensures the
bank can repay its loan obligations. A bank's net worth averaged roughly 12.9% in December