Chapter 27: Problem 5

Explain why the money listed under assets on a bank balance sheet may not actually be in the bank?

Short Answer

Expert verified

The money listed under assets on a bank's balance sheet may not actually be in the bank because not all assets are physical or cash-based, banks operate under a fractional reserve system, and some assets are in the form of loans and investments. This means that a significant portion of the assets on the balance sheet are not physically present as cash but are instead tied up in financial instruments, loans, or other obligations.

Step by step solution

Understand the Bank's Balance Sheet

A bank's balance sheet is a financial statement that reflects the bank's financial position at a specific point in time. It is composed of two main categories, assets and liabilities, along with the bank's equity. Assets represent the resources that the bank owns or controls, while liabilities represent the obligations and debts of the bank. The difference between assets and liabilities is the bank's equity.

Nature of Assets on the Balance Sheet

Assets listed on a bank's balance sheet can be categorized into two main types: (1) physical assets such as cash, buildings, and equipment, and (2) non-physical assets or financial assets such as loans, investments, and securities. It is important to note that not all assets are tangible, and they may not be physically present in the bank.

Fractional Reserve Banking

Banks operate under a system called fractional reserve banking. This means that banks are required to keep only a fraction of their customers' deposits in the form of reserves, while the rest can be used for lending, investing, or other purposes. This implies that a significant portion of the money listed under assets on the balance sheet is not actually in the bank in the form of cash.

Loans and Investments

When a bank lends money to customers or invests in securities, the resulting loans and investments are considered assets on the balance sheet. However, the borrowed money is no longer physically present in the bank, as it is now with the borrowers or invested in financial instruments such as bonds and stocks. Thus, these financial assets do not represent cash held by the bank.

Conclusions

The money listed under assets on a bank's balance sheet may not actually be in the bank because: (1) not all assets are physical or cash-based, (2) banks operate under a fractional reserve system, and (3) some assets are in the form of loans and investments. The balance sheet reflects the financial position of the bank, but it does not provide a direct indication of the actual amount of cash physically present in the bank.