APMacro: Balance Sheet

The U.S. has a fractional reserve banking system in which only a portion or fraction of checkable deposits are backed up by cash in bank vaults or deposits at the central bank. The rest is lent out. The ratio of a bank’s  reserves to its total deposits is called the reserve ratio.

Reserve ratio = bank reserves / total deposits

The Federal Reserve sets a minimum reserve ratio for all banks. banks earn profits by lending the amount of their deposits beyond the required reserves out to borrowers who pay an interest rate higher than the interest rate the bank pay to their depositers. Central to the accounting practices of a bank is a balance sheet called a T account. The balance sheet is a statement of assets and claims on assets that summarizes the financial position of the bank. Every balance sheet must balance; this means that the value of assets must equal the amount of claims against those assets. The claims shown on a balance sheet are divided into two groups called liabilities and the claims of the owners of the firm against the firm’s assets called net worth. A balance sheet is balanced because: 

Assets = liabilities + net worth.

Every $1 change in assets must be offset by a $1 change in liabilities + net worth. Every $1 change in liabilities + net worth must be offset by a $1 change in assets.

1 Creating a Bank
Each item listed in a balance sheet is called an account. The founders of the bank have sold $250,000 worth of shares of stock in the bank. As a result, the bank now has $250,000 in cash on hand and $250,000  worth of stock shares outstanding. The cash is an asset to the bank. The shares of stock outstanding constitute an equal amount of claims that the owners have against the bank’s assets. Those shares of stock constitute the net worth of the bank.

2 Acquiring Property and Equipment
Property and equipment must be acquired for the new bank. The owners purchase a building for $220,000 and pay $20,000 for office equipment. This transaction changes the composition of the bank’s assets. The bank now has $240,000 less in cash and $240,000 of new property assets. Note that the balance sheet still balances.

3 Accepting Deposits
The bank receives $100,000 cash deposit from customers and businesses, which is an asset to the bank. This money is deposited in the bank as checkable deposits or checking account entries, rather than as savings accounts or time deposits. these newly created checkable deposits constitute claims that the depositors have against the assets of the bank and therefore are a new liability account.There has been no change in the economy’s total supply of money, but a change has occurred in the composition of the money supply. Bank money, or checkable deposits, has increased by $100,000. Currency held by a bank is not part of the economy’s money supply. A withdrawal of cash will reduce the bank’s checkable deposit liabilities and its holdings of cash by the amount of the withdrawal. This, too, changes the composition, but not the total supply of money in the economy.

1) Read Chapter 13.1 – 13.2 pp.245-251.  Answer questions #1, 2, 4, 5
2) Learnerator: Production Possibilities Curve #1-20, Inflation #1-30, Unemployment #1-30



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