9.1The Balance Sheet
ASSETS (aka uses of funds) = LIABILITIES (aka sources of funds) + EQUITY (aka net worth or capital).
Savings banks and life insurance companies hold significantly fewer reserves than commercial banks do, because savings banks and life insurance companies do not suffer large net outflows very often. They can often meet outflows from inflows. Savings banks and life insurance companies can usually pay customers' withdrawals from other customers' deposits.
Banks can avoid paying much interest on transaction deposits. Transaction deposits include negotiable order of withdrawal accounts (NOW) and money market deposit accounts (MMDAs), and checkable deposits.
Banks justify the fees by pointing out that it is costly to keep the books, transfer money, and maintain sufficient cash reserves to meet withdrawals.
The administrative costs of non-transaction deposits are lower so banks pay interest for those funds. Non-transaction deposits range from the savings account to negotiable certificates of deposit (NCDs) with denominations greater than $100,000.
Checks cannot be drawn on passbook savings accounts, but depositors can withdraw from or add to the account at will.
Banks also borrow outright from other banks overnight via what is called, the federal funds market, and directly from the Federal Reserve via discount loans (aka advances).
They can also borrow from corporations, including their parent companies if they are part of a bank holding company.
A bank's net worth is the difference between the value of its assets and its liabilities.
Equity originally comes from stockholders when they pay for shares in the bank’s initial public offering (IPO) or direct public offering (DPO). Later, it comes mostly from retained earnings.
Regulators watch bank capital closely because of the transaction costs, and asymmetric information, the more equity a bank has, the less likely it is that it will fail. However, even well-capitalized banks can fail very quickly.
Intermediaries link investors (purchasers of banks’ liabilities) to entrepreneurs (sellers of banks’ assets) in a more sophisticated way than mere market facilitators like dealer-brokers and peer-to-peer bankers do.
Banks (aka depository institutions) turn short-term deposits into long-term loans. They borrow short and lend long.
The liabilities of insurance companies are said to be contingent because they come due if an event happens rather than after a specified period of time.
Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.
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