The Bank Balance Sheet
A bank holds assets (reserves, securities, and loans) funded by liabilities (deposits and borrowings) plus bank capital. Capital is the owners’ stake, the cushion that absorbs losses before depositors are touched.
Try it yourself
Bank Capital & Leverage
Capital is the sliver of assets funded by the owners. Thinner capital lifts leverage and return on equity, but a fall in asset value burns through that cushion faster. How much loss can the bank absorb before it is insolvent?
Leverage 12.5× turns a 1.0% return on assets into a 12.5% return on equity — but the same 12.5× means a loss above 8.0% of assets erases the owners' stake.
Reflect: If higher leverage always raises ROE, why do regulators force banks to hold minimum capital? Who bears the loss once capital is gone?
Why it matters
A bank borrows short through deposits and lends long through loans, earning the spread. Capital is the thin equity slice standing between loan losses and the depositors’ money, absorbing losses before any depositor is touched. The thinner that slice, the higher the leverage, which lifts return on equity (ROE equals return on assets times leverage) in good times but thins the very cushion protecting depositors in bad times.
Formulas
Worked examples
A bank has $100 of assets funded by $92 of deposits and borrowings plus $8 of capital. What happens after a $5 loan loss, and after a $9 loss?
A $5 loss cuts capital from $8 to $3, and depositors are untouched. A $9 loss wipes out the $8 of capital and eats into deposits, so the bank is insolvent.
Common mistakes
- ✗Deposits are a bank’s assets. Deposits are liabilities, money the bank owes to its customers.
- ✗A bank lends out the exact cash you deposit. It keeps a fraction as reserves and creates new loans, so reserves and deposits are not the same pool.
Revision bullets
- •Assets are reserves, securities, and loans
- •Liabilities are deposits and borrowings
- •Capital is the owners’ loss-absorbing cushion
Quick check
On a bank balance sheet, customer deposits are
Connected topics
Sources
- Mishkin (2018), Ch. 9Mishkin, F. S. The Economics of Money, Banking, and Financial Markets. 12th ed. Pearson, 2018. ISBN 978-1-292-26885-9.The bank balance sheet and the basic operation of a commercial bank.