3.3.1. Balance Sheet of a Fictional Bank

Let us construct a fictional balance sheet for this bank. Balance sheet is a record of assets and liabilities of any firm. Conventionally, the assets of the firm are recorded on the left hand side and liabilities on the right hand side. Accounting rules say that both sides of the balance sheet must be equal or total assets must be equal to the total liabilities.

A balance sheet provides a snapshot of a bank’s financial position at a given point in time. It shows what the bank owns (assets) and what it owes (liabilities). On a balance sheet, assets are listed on the left side and liabilities on the right side. According to accounting principles, the total assets must equal total liabilities plus net worth. This equality is crucial because it reflects the financial stability of the bank.

Think of a balance sheet like a detailed inventory list in a grocery store. On one side, you have all the products (assets), and on the other side, how much you owe your suppliers (liabilities). Just like a store needs to balance what’s on its shelves with what it owes, a bank needs to make sure its assets match its liabilities.

Assets are things a firm owns or what a firm can claim from others. In case of a bank, apart from buildings, furniture, etc., its assets are loans given to the public. When the bank gives out loan of Rs 100 to a person, this is the bank’s claim on that person for Rs 100. Another asset that a bank has is reserves.

Assets can be anything that has value and can be converted into cash. For a bank, primary assets include the loans it has issued to customers. When a bank lends money, it records that as an asset, which represents money expected to be returned with interest. Reserves, or the money kept on deposit with the central bank, are also crucial as they provide liquidity for the bank's operations.

Imagine a school that has a library (asset) full of books (loans to students). When a student checks out a book, the school expects it to be returned, just as the bank expects loan payments back. The money held in reserve is akin to having some extra textbooks on hand that can be used anytime, ensuring students can always borrow when needed.

Liabilities for any firm are its debts or what it owes to others. For a bank, the main liability is the deposits which people keep with it.

Liabilities represent the bank's obligations to its depositors. When individuals deposit money in a bank, the bank has a legal obligation to return that money upon demand. These deposits are considered liabilities because they are money the bank owes to its customers, and they must be managed carefully to maintain trust and avoid liquidity issues.

Consider a library again. If the library takes in books from the community for use by others (deposits), it has to keep a record and ensure those books are available when the owners want them back. If the library loses some books or cannot return them, it would break trust with the community, similar to how a bank would if it couldn't return customers' deposits.

Let our fictional bank start with deposits (liabilities) equal to Rs 100. This could be because Ms Fernandes has deposited Rs 100 in the bank. Let this bank deposit the same amount with RBI as reserves. Table 3.1 represents its balance sheet.

3.1 Balance Sheet of a Bank

Assets Liabilities Reserves Rs 100 Deposits Rs 100 Net Worth Rs 0 Total Rs 100 Total Rs 100 If we assume that there is no currency in circulation, then the total money supply in the economy will be equal to Rs 100. M = Currency + Deposits = 0 +100 =100

In this example, Ms. Fernandes deposits Rs 100 in the bank, which creates a liability for the bank because it must return that money to her when requested. Simultaneously, this amount becomes an asset for the bank as it can be used for lending. The balance sheet shows that assets equal liabilities, which is fundamental for financial health. Additionally, since there are no physical currency notes in circulation, the total money supply in the economy is represented entirely by the bank's deposits.

Envision Ms. Fernandes as someone starting a small community fund. She contributes Rs 100, which functions as a promise from the fund to return her money when needed. The fund can then use that money to help others in the community, ensuring trust and balance within. This way, Ms. Fernandes' Rs 100 influences the entire community without needing physical cash circulating everywhere.

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