To keep this post short and sweet, I will only go through the bare basics. For more complicated overviews, you’ll need to find a much longer article.
Main Factors
The main elements you need to know are these: Loans, deposits, and reserves.
Of course, there are other elements like assets the bank owns such as buildings and securities, but those are pretty typical factors on any company’s balance sheet. What makes a bank’s balance sheet different are the aforementioned three elements.
Hypothetical: You Deposit Cash
You find $100 cash in your drawer and eventually deposit it into your bank account for safekeeping. That money, of course, is your asset. But for the bank, it’s a liability since they essentially owe you that money when you need it and have to pay you interest.
The bank uses your funds to create loans and invest. Loans, mortgages, owned securities and bonds, all of those make up a bank’s assets.
Reserves
Reserves are also a part of a bank’s assets!
Reserves are fluid assets that are required by regulators to ensure banks have enough to pay their depositors. Primary reserves include cash and percentages of deposits, and secondary reserves are financial assets that can be easily sold for cash, like government bonds.
The current reserve requirement is 0%. During the pandemic, regulators reduced the requirement to ensure banks had enough cash to handle demand from panicked depositors. It should be noted that reserves held at the Federal Reserve are currently earning 5.4%, so there is an enticing incentive to maintain reserves.
You may hear the term “bank run”. That is what regulators want to avoid.
[A bank run is] …when too many customers withdraw all their money simultaneously from their deposit accounts with a banking institution for fear that the institution may be, or will become, insolvent.
Corporate Finance Institute
Lastly, don’t mistake commercial banks (what we’re discussing here) for central banks. Central bank balance sheets are different.
Check out our previous 2-minute overview of uranium, gold, and silver markets!