Items of the Balance Sheet of a Bank

The balance sheet of a commercial bank like any other balance sheet comprises two sides; conventionally the left side shows liabilities and capital, while the right side shows assets. A bank’s assets are indications of what the bank owns or the claims that the bank has on external entities: individuals, firms, governments, etc. A bank’s liabilities are indications of what the bank owes as claims which are held by external entities of the bank. The net worth or capital is calculated by subtracting total liabilities from total assets.

Assets-Liabilities = Net worth

Or

Assets= Liabilities+ Net worth

Liabilities of a Bank

Liabilities of a commercial bank are claims on the bank. They represent the amounts which are due from the bank to its shareholders, depositors, etc. Bank liabilities are the funds that banks obtain and the debts they incur, primarily to make loans and purchase securities. The major components of the liabilities of a bank are as follows:

1. Capital: Capital and reserves what the customer regards as an asset, the same bank deposit is a liability for the bank as the customer gains claims over them. The paid up share capital implies the liability of the bank to its shareholders. It is the amount actually received by the bank out of the total subscribed capital. Adequate share capital is considered as a source of strength for the bank as it provides confidence to the depositors about the solvency of the bank.

2. Reserve Fund: Reserves are created out of the undistributed profits which are retained over a period of years by the bank. Creation of reserve fund is a statutory requirement in most of the countries of the world. Reserve requirements limit the portion of the bank’s funds that it can use to give loans and purchase securities. Banks build up reserves to strengthen their financial position and also to meet unforeseen liabilities or unexpected losses. Reserve fund, together with capital represents the capital structure or net worth of the bank. Net worth is a residual term that is calculated by subtracting total liabilities from total assets.

3. Deposits: Deposits constitute the major sources of funds for banks. What the customer regards as an asset, the same bank deposit is a liability for the bank as the customer gains claim over them. Banks get funds from investment and these are indirectly the source of its income. Banks keep a certain percentage of its time and demand deposits in cash and after meeting the liquidity requirement, they lend the remaining amount on interest. Indian banks accept two main types of deposits, demand deposits and term deposits. Demand deposits, as the name suggests, are repayable on particular period. The prosperity, growth and goodwill of the bank depend upon the amount of these deposits. Fixed deposits have specific maturity and so can be used by banks to earn income. Demand deposits can be further subdivided into current and savings. Current deposits are chequeable accounts with no restriction on the number of withdrawals. It is possible to obtain clean on secured overdraft on these accounts. Saving deposits are more liquid than fixed deposits as money can be withdrawn when needed, though some banks restrict the number of withdrawals per-month or per-quarter.

4. Borrowing from Other Sources: In case of need, banks can borrow from the Reserve Bank of India, other commercial banks, development banks, non-bank financial intermediaries like LIC, UTI, GIC, etc. Secured loans are obtained on the basis of some recognized, securities whereas unsecured loans are out of its reserve funds lying with the central bank.

5. Other Liabilities:  Other liabilities include bills payable, bills sent for collection, acceptance, endorsement, etc. The amounts of all such bills are shown on the liability side of the balance sheet.

6. Contingent Liability: Contingent liabilities are those liabilities which may arise in future but cannot be determined accurately, e.g. guarantee given on behalf of others, outstanding forward exchange contracts, etc. These are shown on the liability side as a rough estimate.

7.Profit or loss: Profit is unallocated surplus or retained earnings of the year after paying tax and dividends to shareholders. As shareholders have claim over the bank’s profit, it is shown as a liability. In case of loss, the figure will be shown on the assets side.

Assets of a Bank

Like all other business firms banks also strive for profit. Commercial banks use their funds primarily to purchase income earning assets, mainly loans and investments. These assets are shown in the balance sheet of the bank in decreasing order of the liquidity. The major assets of the bank include:

1.  Cash:  Cash in hand and cash balances with the Reserve Bank of India are the most liquid assets of a bank. Cash assets provide bank funds to meet the withdrawals of deposits and to accommodate new loan demand. Maintaining of cash reserve ratio with RBI is a statutory requirement for the banks.

2. Money at Call and Short Notice: This is the money lent by the banks to other banks, bill brokers, discount houses and other financial institutions for a very short period of time varying from 1 to 14 days. When these funds are repayable on demand without prior notice, it is called money at call. On the other hand, if some prior notice is required, it is known as money at short notice. In the balance sheet, both are shown as a single item on the asset side. Banks charge very low rate of interest on these. If the cash position continues to remain comfortable, these loans may be renewed day after day.

3. Loans and Advances: Loans and advances are the bank’s earning assets. The interests earned from these assets generate the bulk of commercial bank revenues. Loans may be demand loans or term loans which may be repayable is single or in many installments. Advances are usually made in the form of cash credit and overdraft.

4. Investments: Commercial banks use funds for investment in various types of securities like the gilt edged securities of the central and state government as well as shares and debentures of corporate undertakings. The securities issued by government are safe from the risk of default though they are subject to risk from change in rate of interest. These securities include treasury bills, treasury deposit certificates, etc. The long-term investments have the greatest profitability.

5. Bills Receivable: Bills receivable and other credit instruments accepted by the commercial banks on behalf of their customers are also shown on the asset side of the balance sheet. The reason is that the bank has a claim on the payee, on whose behalf it has accepted the bills. Thus, the same amount appears on assets as well as liabilities sides of the balance sheet of the bank.

6. Other Assets: These include the physical assets of a bank like the bank premises, furniture, computers, machine equipment, etc. These also include the collaterals which the bank has repossessed from the borrowers in default.