A balance sheet (aka statement of condition , statement of

financial position) is a financial report that shows the value of a

company's assets, liabilities, and owner's equity at a specific period of
time, usually at the end of an accounting period, such as a quarter or a
year. Anasset is anything that can be sold for value. A liability is an
obligation that must eventually be paid, and, hence, it is a claim on
assets. The owner's equity in a bank is often referred to as bank
capital, which is what is left when all assets have been sold and all
liabilities have been paid. The relationship of the assets, liabilities, and
owner's equity of a bank is shown by the following equation:

Bank Assets = Bank Liabilities + Bank Capital

A bank uses liabilities to buy assets, which earns its income. By using
liabilities, such as deposits or borrowings to finance assets such as loans
to individuals or businesses, or to buy interest earning securities, the
owners of the bank can leverage their bank capital to earn much more
than would otherwise be possible using only the bank's capital.

Assets: Uses Of Funds

Assets earn revenue for the bank and includes cash, securities, loans,
and property and equipment that allows it to operate.

Cash

One of the major services of a bank is to supply cash on demand,

whether it is a depositor withdrawing money or writing a check, or a
bank customer drawing on a credit line. A bank also needs funds to pay
bills, but while bills are predictable in both amount and timing, cash
withdrawals by customers are not.

Hence, a bank must maintain a certain level of cash compared to its

liabilities to maintain solvency. A bank must hold some cash
as reserves , which is the amount of money held in a bank's account at
the Federal Reserve (Fed). The Federal Reserve determines the legal
reserves , which is the minimum amount of cash that banks must hold
in their accounts to ensure the safety of banks and also allows the Fed to
effect monetary policy by adjusting the reserve level. Often, banks will
keep excess reserves for greater safety.

To do business at its branches and automated teller machines (ATMs), a

bank also needs vault cash, which includes not only cash in its vaults,
but also cash elsewhere on a bank's premises, such as teller drawers,
and the cash in its ATM machines.
 Some banks, usually smaller banks, also have accounts at larger banks,
called correspondent banks . which are usually larger banks that
often borrow from the smaller banks or performs services for them. This
relationship makes lending expeditious because many of these smaller
banks are rural and have excess reserves whereas the larger banks in
the cities usually have a deficiency of reserves.

Another source of cash is cash in the process of collection .

When a banks receives a check, it must present the check to the bank on
which it is drawn for payment, and, previously, this has taken several
days. Nowadays, checks are being processed electronically and many
transfers of funds are being conducted electronically instead of using
checks. So this category of cash is diminishing significantly, and will
probably disappear when all financial transactions finally become
electronic.

Securities

The primary securities that banks own are United States Treasuries and
municipal bonds. These bonds can be sold quickly in the secondary
market when a bank needs more cash, so they are often referred to
as secondary reserves.

The recent credit crisis has also underscored the fact that banks held
many asset-backed securities as well. United States banks are not
permitted to own stocks, because of the risk, but, ironically, they can
hold much riskier securities called derivatives.

Loans

Loans are the major asset for most banks. They earn more interest than
banks have to pay on deposits, and, thus, are a major source of revenue
for a bank. Often banks will sell the loans, such as mortgages, credit
card and auto loan receivables, to be securitized into asset-backed
securities which can be sold to investors. This allows banks to make
more loans while also earning origination fees and/or servicing fees on
the securitized loans.

Loans include the following major types:

• business loans, usually called commercial and industrial (C&I) loans

• real estate loans
o residential mortgages
o home equity loans
o commercial mortgages
• consumer loans
•
o credit cards
 o auto loans
• interbank loans

Liabilities: Sources of Funds

Liabilities are either the deposits of customers or money that banks

borrow from other sources to use to fund assets that earn revenue.
Deposits are like debt in that it is money that the banks owe to the
customer but they differ from debt in that the addition or withdrawal of
money is at the discretion of the depositor rather than dictated by
contract.

Checkable Deposits

Checkable deposits are deposits where depositors can withdraw the

money at will. These include all checking accounts. Some checkable
deposits, such as NOW, super-NOW, and money market accounts pay
interest, but most checking accounts pay very little or no interest.
Instead, depositors use checking accounts for payment services, which,
nowadays, also includes electronic banking services.

Before the 1980s, checkable deposits were a major source of cheap

funds for banks, because they paid little or no interest on the money.
But as it became easier to transfer money between accounts, people
started putting their money into higher yielding accounts and
investments, transferring the money when they needed it.

Non-transaction Deposits

Nontransaction deposits include savings accounts and time

deposits , which are basically certificates of deposits (CDs). Savings
accounts are not used as a payment system, which is why they are
categorized as nontransaction deposits and is also the reason why they
pay more interest. Savings deposits of yore were mostly passbook
savings accounts , where all transactions were recorded in a
passbook. Nowadays, technology and regulations have
allowed statement savings where transactions are recorded
electronically and may be viewed by the depositor on the bank's website
or a monthly statement is mailed to the depositor; and money market
accounts , which have limited check writing privileges and earn more
interest than either checking or savings accounts.

A Certificate of Deposit (CD) is a time deposit where the depositor

agrees to keep the money in the account until the CD expires. The bank
compensates the depositor with a higher interest rate. Although the
depositor can withdraw money before the CD expires, banks charge a
hefty fee for this.
 There are 2 types of certificates of deposit (CDs): retail and large. A
retail CD is for less than $100,000 and is generally sold to individuals. It
cannot be resold easily. Large CDs are for $100,000 or more and are
highly negotiable so they can be easily resold in the money markets.
Large negotiable CDs are a major source of funding for banks.

Nontransaction deposits in depository institutions are now insured to

$250,000 by the Federal Deposit Insurance Corporation (FDIC).

Borrowings

Banks also borrow money, usually from other banks in what is called
thefederal funds market , so-called because funds kept in their
reserve accounts at the Federal Reserve are called federal funds. Banks
with excess reserves, which are usually smaller banks located in smaller
communities, lend to the larger banks in metropolitan areas, which are
usually deficient in reserves.

The interbank loans in the federal funds market are unsecured, so banks
only lend to other banks that they trust. Banks also borrow from
nondepository institutions, such as insurance companies and pension
funds, but most of these loans are collateralized in the form of
a repurchase agreement (aka repo), where the bank gives the lender
securities, usually Treasuries, as collateral for a short-term loan. Most
repos are overnight loans that are paid back with interest the very next
day.

As a last resort banks can also borrow from the Federal Reserve (Fed),
though they rarely do this since it indicates that they are under financial
stress and unable to get funding elsewhere. However, during the credit
freeze in 2008 and 2009, many banks borrowed from the Fed because
they could not get funding elsewhere.

Bank Capital

Banks can also get more funds either from the bank's owners or, if it is a
corporation, by issuing more stock. For instance, 19 of the largest banks
that received federal bailout money during the credit crisis raised $43
billion of new capital in 2009 by issuing stock because their reserves
were deemed inadequate in response to stress testing by the United
States Treasury.

Graph spanning 1990 - 2007 showing how the number of banks has declined
continuously, and how the share of all bank assets of the 10 largest and 100
 largest banks has grown in the same time period.

Source: http://www.federalreserve.gov/pubs/bulletin/2008/articles/bankprofit/default.htm

New Accounting Rules For Valuing Assets

Bank capital, which is equal to the value of total assets minus total
liabilities, is the bank's net worth. However, recent accounting changes
have made it more difficult to determine a bank's true net worth.

Banks were having a tough time in early 2009. The credit crisis has
caused many defaults on mortgages, credit cards, and auto loans,
forcing them to increase their loan loss reserves and to devalue many of
the asset-backed securities that they held based on these loans.
Consequently, banks were suffering major losses. A major contributor to
these losses was because the asset-backed securities that were still held
by the banks had to be valued by mark-to-market rules, and since no
one was buying these toxic securities, their mark-to-market value was
very low.

To restore confidence in the banking system, the government allowed

some changes to the accounting rules that artificially increased the
revenues of the banks. The Financial Accounting Standards Board (FASB)
allowed banks to value their assets according to fair value, as
determined by the banks. However, many critics assert that there will be
more defaults on the underlying loans of these securities, and, thus, will
have to be accounted for in the future.

Banks also didn't have to write down assets that they intended to
keep to maturity. Here, again, critics argued that there will probably be
many more defaults on the underlying loans, especially since the
unemployment rate is still rising, so they will be forced to write them
down in the future.

Additionally, banks could record income on their books if the value of the
debt falls in the market. The reason for this allowance is because they
could buy back their own debt in the market, thus reducing their debt for
a fraction of its face value. However, critics have pointed out that if a
bank doesn't have the money to buy back its debt, it could still record
the reduced value as revenue even though the bank would have to pay
the principal back by the debt's maturity.

Citigroup is a good example of how much the new accounting rules can
change the income reported by a bank. According to this Bloomberg
article, the $1.6 billion profit reported by Citigroup under the new
accounting rules for its 1st quarter in 2009 would be reduced to a $2.5
billion loss under the old accounting rules