Macroeconomics
E. Banks and Creation of Money Basic Accounting Principles Likeanyotherbusiness,banksneedtokeeptrackofwhattheyownandwhattheyowe.Tounderstand how they do that, one should learn some basic principles of accounting. In accounting, assets represent anything of value that a frm owns . For a bank, assets include real assets suchasbuildings,furniture,etc.,inadditiontothe moneyandfnancialassets theyownsuchas cash in vaults, bonds, stocks, and loans . A bank records a loan as an asset because the borrower promises to repay a certain sum of money on a certain date. This promise isworthsomethingtothe bank. Other bank assets include deposits at the Fed (central bank), called reserves. These are portions of the bank’s deposits kept at the Fed for reasons that will be discussed soon. Liabilities ,ontheotherhand,representafrm’sdebts,or whatitowestoothers . Forabank,liabilities includedepositsandsavingsaccounts becausetheyarepromisestopaymoneythatcustomerskept withit.Whenpeoplemakedepositsinabank,theyarebasicallymakingaloantothebank,sothebank owes them that amount. Thebasicruleofaccountingstatesthatifweaddupafrm’sassetsandthensubtractitsliabilities(the totalamountitowestoeveryonewhohaslentitfunds),thedifferenceisthefrm’snetworth. Networth representsthevalueofthefrmtoitsownersorstockholders. Forinstance,abankthatowns$50million in assets and owes $20 million in liabilities is worth $30 million.
Assets − liabilities = net worth
Therefore, we can also deduce that:
Assets = liabilities + net worth
A T-account is used to illustrate a bank’s fnancial position . It is a simple balance sheet, which, by convention, lists the bank’s assets on the left side and its liabilities and net worth on the right side. Bydefnition,thebalancesheetorT-accountalwaysbalances,meaningthatthesumoftheitemsonthe left side (assets) is equal to the sum of the items on the right side (liabilities + net worth). In the example below, the bank has $90 million in assets, of which $10 million are reserves (the depositsthebankhasmadeattheFedanditscashonhand),and$80millionareloans.Ontheliabilities side, the bank owes $60 million in deposits, which means that ithasanetworthof$30million($90 million − $60 million).
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